The UK was warned yesterday that it is among the European Union states that faces the risk of contagion from the Greek crisis, with "very real, common threats" to its financial systems.
As a stunned Greece, still struggling to come to terms with the deaths of three people in protests on Wednesday, approved cuts to address its financial crisis, one of the leading credit ratings agencies said British banks were "vulnerable" to shocks of the kind now reverberating around the eurozone.
The Greek finance minister, George Papaconstantinou, urged parliament not to flinch from passing a widely-detested €30bn package of tax rises and spending cuts, imposed as a condition for €110bn of loans from the EU and International Monetary Fund.
George Papandreou, the Prime Minister, said Greeks faced a simple choice. "Today things are simple," he said. "Either we vote and implement the deal, or we condemn Greece to bankruptcy."
But Moodys, the credit rating agency warned Italy, Portugal, Spain, Ireland and the UK were at risk from investors turning their backs on government bonds. "Each of the banking systems faces different challenges, but the contagion risk could dilute these differences and impose very real, common threats on all of them." Markets are indicating a growing conviction that Portugal and even Spain may follow Greece into crisis, raising the chances of a break-up of the single currency.
In a joint letter released last night ahead of a summit of European leaders in Brussels today, Nicolas Sarkozy, the French President, and Angela Merkel, the German Chancellor, called for stronger budgetary oversight inside the eurozone. "We must first reinforce the economic governance of the euro area", they wrote. "The Greek government has committed to taking courageous measures. We fully support its determination and we are convinced that it will allow Greece to address its fiscal and economic challenges and restore market confidence."
The summit will consider tougher sanctions for countries that fail to keep their deficits under control.
But the lack of confidence by the markets in the political handling of the Greek crisis has sent the euro plunging to a 14-month low against the dollar to $1.27, a six-month low against the pound and an all-time low against the Swiss Franc. The FTSE-100 index of leading shares has fallen more than 5 per cent this week, mostly as a result of "contagion" worries. A Greek default is being talked of as the "New Lehmans", echoing the economic slaughter that followed the collapse of the Wall Street firm in September 2008.
Losses on Greek government bonds – which have become virtually unmarketable in the crisis, like the "toxic debts" that brought Wall Street and City firms down two years ago, could be catastrophic in the case of a default. According to the Bank for International Settlements, of the $240bn in Greek government bonds held by overseas investors, a substantial proportion is in the vaults of the French banks – $78bn. Germany's banks are next, on $45bn of exposure, with the British and Dutch banks following on $15bn and $12bn respectively. But those losses would be multiplied dramatically if the crisis spread. That would spark a second credit crunch, overwhelming already enfeebled banks and plunging the European economy into a deep recession.
While the direct losses facing British banks may be relatively small, they are closely enmeshed through the money markets to the continental banks whose potential losses are so much larger. Should suspicious banks refuse to lend to each other again, as they did in 2008, the consequences would be no less serious. Anecdotal evidence suggests Greek, and to a lesser extent Spanish and Portuguese banks are starting to be frozen out of international money markets, and that could be the sign of a wider meltdown.