Germany Prepares for Greek Default

German Chancellor Angela Merkel is preparing the nation’s banks for the event that Greece fails to institute the necessary austerity measures of its aid package and is unable to receive the next tranche of its bailout package, in which case the nation would go into default. Merkel’s government is debating over how to shore up German banks in preparation for what seems a sure thing.

The yield on Greek two-year notes rose to above 60% Monday for the first time, while credit-default swaps to insure the country’s five-year bonds closed on Friday at an all-time high of 3,500 basis points, giving Greece the highest contracts in the world.

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Germany has been the largest contributor to all three European bailouts, fighting for almost two years to contain the region’s debt crisis. However, Greece has not yet met the terms of its next tranche of aid, and Germany has threatened to withhold the next bailout-loan payment, as has France, which would almost certainly result in default.

Of course, the Greek government could decide to exit the euro zone. Lars Feld, a member of Germany’s council of economic advisers, said that a “disorderly restructuring” of Greece could take place should that be the case, though he doesn’t think it could be easily done. “There are many, many technical difficulties and the contagion then would be much, much higher and much stronger than anything we observe” under an orderly restructuring.

Greek Prime Minister George Papandreou has said that the government’s top priority is “to save the country from bankruptcy” and that they “will remain in the euro,” even if it “means difficult decisions.”

In the meantime, European bank credit risk has surged to an all-time high and the euro is down 0.6% against the dollar today as investors fear Greece will not implement austerity moves fast enough to get the sixth payment from last year’s 110 billion-euro bailout.

Bank of France Governor Christian Noyer says French banks have the capital to withstand a Greek default, but some of the country’s largest banks by market value — including BNP Paribas, Societe Generale, and Credit Agricole SA — could have their credit ratings cut by Moody’s Investors Service as soon as this week because of their Greek holdings. Back in June, Moody’s warned that the three banks were placed on review to examine “the potential for inconsistency between the impact of a possible Greek default or restructuring.”

But German banks are Greece’s biggest lenders, with a total of $14.1 billion in Greek government bonds as of the end of March. French banks follow in second with $13.4 billion. For that reason, Germany has reportedly been constructing a contingency plan to shield German banks from possible losses from a Greek default. Germany is preparing for the possibility that some of its banks and insurers could face a 50% loss on their Greek bonds if the next tranche of aid is withheld from Greece.

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But Germany’s actions aren’t wholly selfish says Klaus-Peter Flosbach, budget-policy spokesman for Merkel’s Christian Democratic Union and the Christian Social Union in parliament. “It would be of central importance to keep the possibility of contagion in the euro zone as low as possible,” said Flosbach, but Germany is “not looking into pushing Greece out of the euro zone.”

According to Fredrik Erixon, head of the European Centre for International Political Economy in Brussels, Germany’s concern is broader than just Greece, and centers on how euro-zone banks and economies would cope if the debt crisis were to spread. “Germany is preparing for the worst, which is that the crisis in the euro zone is going to be much bigger for everyone,” Erixon said.