Investing 101

What Greece’s Bailout Means for the American Investor

Written by Mint.com
Published Feb 23, 2012 - [Updated Jul 6, 2022]
5 min read
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Will the latest bailout of Greece finally end the European sovereign debt crisis? Should you, as a typical American investor, care if it does? Both answers are a bit tricky given the political, economic and social turmoil that this crisis has created since starting nearly three years ago. But the general feeling among investors, as well as confidential government communiqués, is that the Greek crisis is far from over and that its repercussions will continue to impact stocks and investments here at home until there is a viable resolution.

The Details of the Deal

First let’s discuss what this latest deal resolves. Greece will be given 130 billion euros in cash by the European Union, so that it makes its latest debt payment due in March. It will also lower Greece’s debt burden by forcing private investors to take losses on their holdings. All in all, the cuts and the extra money should allow Greece to run its government and stay current on its debt payments for at least the next year or so.

Unless you are invested in Greek bonds or in an ETF that mirrors that debt, you probably aren’t going to feel a direct impact from this deal. If you did buy Greek debt, I am sorry to tell you that the deal slashes the face value of your bonds by 53.5%, lowers the interest rate you were expecting and extends the maturities of your coupon payments farther out in the future. Altogether, the net present value of your losses, which include losses connected to the lower interest rates and payments you thought you were going to receive, will probably top 70%.

Will Greece Be Able to “Live Within Its Means?”

Greece will see its debt burden slashed to a more manageable level, which should allow the country, in theory, to stay current on its payments, therefore avoiding another crisis. But, of course, things aren’t that simple. In exchange for the cash, Greece was forced to cut its budget, raise taxes and fire a bunch of government employees. While this forces Greece to “live within its means,” it also means that its economy will shrink considerably. That will lower the amount of revenue it is able to bring in through taxes, setting the stage for yet another crisis.

A confidential communiqué from the International Monetary Fund, uncovered by the Financial Times, concluded that it is highly unlikely that Greece will be able to stand on its two feet for very long after the deal is implemented and that the country will need to come back to the table and request more money. The bailout has also set a dangerous precedent, in which other European countries in dire straits will point to as they try and deal with their own debt woes. Expect to see more bailouts from countries like Portugal in the near future.

Why Does it Matter to the American Investor?

So if you’re not a European sovereign bond investor, why does this all matter? Well, the interconnected nature of the world economy unfortunately brings what was once a local economic panic right to your doorstep. Here’s one example: A continued weak European economy will hurt American companies that do business on the continent. Those American companies will start to cut expenses back at home, hurting local businesses and so on down the line.

That’s the theory, anyway. But the more direct impact investors will feel will come from investments made in the stock, bond and currency markets. This deal will impact the way the Euro trades against the U.S. Dollar – if it is successful, the Euro should strengthen, if it looks like a dud, the Euro should weaken. If you are trading currency futures, you may have noticed that the Euro strengthened on Tuesday after the deal but quickly gave up its gains on Wednesday after a terrible economic report came out of the continent.

The Euro Vs. the Dollar

If you are planning your next European vacation, you might want to root for more pain in Europe as it will probably cause the Euro to weaken against the Dollar, making your vacation cheaper. If you don’t mind riot and protests, it might be a great time to see the Parthenon in Athens as hotels slash their rates. But a weaker Euro also means U.S. goods exported to Europe will be more expensive, hurting sales. This would have an negative impact on the value of those U.S. companies that export heavily to Europe.

The U.S Stock Market

If you are invested in U.S. stocks, you are in for a wild ride. The markets have been volatile for months thanks to the crisis. The Dow Jones Industrial Index initially strengthened on the news Tuesday that Europe was able to come to a deal with Greece, at one point topping 13,000 for the first time since the financial crisis broke out in March of 2008. But then, when reality of the deal sank in on Wednesday, stocks took a tumble. Equity investors need to watch the news carefully as even the most benign headline out of Europe will cause nervous investors to sell, sending stock prices lower.

Long-term Concerns

But the long term worry for equity investors is whether or not the EU can survive more bailouts. The one thing Wall Street hates most is uncertainty and this crisis is full of it. The debt burden of the so-called PIIGS countries (Portugal, Ireland, Italy, Greece & Spain), is large and won’t just go away with one deal. Even if Greece is saved, there is still a lot more countries, bigger countries, in need of saving before we can call an end to this crisis. This is critical because if the EU or the eurozone collapses, stock markets around the globe would fall sharply amid fear of a global recession.

These things happen fast and somewhat unexpectedly, so it is hard to tell if one is on the way. Until then, it will pay to watch the markets intently so that you can quickly protect your portfolio from a nasty European contagion.

Cyrus Sanati is a frelance financial journalist whose work has appeared in dozens of leading publications, including The New York Times, BreakingViews.com, and WSJ.com. Follow Cyrus on Twitter @csanati.