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How Greek bond failure will hurt the U.S. economy

COMMENTARY Negotiations over Greek debt repayment are on the verge of collapse. If that sentence fails to alarm you, you're not alone. Unfortunately, this could be a very big deal indeed. If Athens can't convince creditors to take less money than they were originally promised, the shock waves will hit America's tentative economic recovery hard. Think Lehman Brothers, only bigger.

The talks were suspended Friday because a number of hedge-fund investors will make more money if Greece defaults -- money that will come out of the U.S. banking system, among other sources. 

According to a statement by the group representing private investors:

Under the circumstances, discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach. We very much hope, however, that Greece, with the support of the Euro Area, will be in a position to re-engage constructively with the private sector with a view to finalizing a mutually acceptable agreement.

It is fairly odd that anyone is having discussions about Greece repaying anything. The nation is stone-cold, flat-out broke. The only reasons it hasn't defaulted already are A) foreign handouts and B) some very artful language. The Greek government can't pay its current bills, never mind its debt -- so even if 100 percent of all its debts were forgiven, it would still be bankrupt.

Nevertheless, investors are balking at a deal voluntarily to take a 50 percent reduction in the money owed them from Greek bonds. Since Greece can't pay anything, why not agree to the 50 percent? This seems like, as the great writer Jorge Louis Borges once said, a case of two bald men fighting over a comb. But it is not. 

The key word here is "voluntarily." If the creditors agree to taking less money, Greece will not technically be in default. Some of the creditors want the default to be official so they can cash in their credit default swaps, the insurance they bought to protect their investments. They will get 100 percent of their money back -- not from Athens, but from all the banks that sold them the insurance.

Unfortunately, these banks don't have enough money to pay off that insurance. No one is going to lend them the money to do that because they have a huge amount of assets that are -- and I'm using a technical term here -- total crap. So they will have to call in loans from other banks that also don't have money to pay off their loans and who will in turn do the same. The likely outcome of this is a bunch of banks and possibly even financial systems having to say publicly their debts far exceed their assets. In other words, they will go bust. Any resemblance between this and the U.S. financial system in 2008 is purely correct. Except it is on a much larger scale.

If all those dominoes fall, they will squash any hopes of our having an economic recovery flatter than Iowa. So, sadly, that is why Greece matters right now.

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