If Greece has to write-down its debt and pay its European lenders a fraction of their promised returns, the situation could get ugly. Desmond Lachman explains (reminder of the interconnectivity of European debt after the excerpt)
The even greater risk to the European banking system from a Greek failure is that it would bring very much into play Portugal, Spain, and Ireland. These countries, which between them have around US$1.5 trillion in sovereign debt, suffer from similar, albeit less acute, public finance and international competitiveness problems. And they too are stuck in a Euro-zone straightjacket that severely constrains their ability to deal with these problems in a credible manner.
In considering the timing of the Federal Reserve's exit strategy, Bernanke would make the gravest of errors were he to underestimate the potential fallout of a Greek failure on the U.S. and global economies. For not only would a further shock to the European banking system diminish U.S. export prospects by tipping the European economy back into recession and by materially weakening the euro, it would also all too likely be accompanied by a return in spades of risk aversion in global financial markets.
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