Should the U.S. worry about a Greek default?

According to most recent press accounts, it is no longer a matter of whether Greece will default on its sovereign debt.  Instead it is a matter of when the default will take place and how much collateral damage will there be.  Gretchen Morgenson of NYT had a good writeup on Sunday about how this could play out.  Losers in a world with no bailouts: those holding Greek bonds and those who wrote credit default swaps to protect those bondholders that elected for insurance against default.  Because these swaps are not traded publicly, no one knows if the insurers have the capability of covering their debts.

One more complication: Portugal, Italy, Ireland, and Spain (with Greece known collectively as the PIIGS) are not in dramatically better shape than Greece.  Morgenson notes that European banks are holding a much higher percentage of their assets in sovereign bonds than did American banks hold in mortgage-related securities three years ago.

Regulators encouraged European banks to hold huge amounts of European government debt by letting them account for these investments as if they posed zero risk. That meant the banks didn’t need to set aside a single euro in capital against those holdings.

Now, according to an analysis by Autonomous Research, 43 large European banks hold debt in troubled sovereigns that is equal to 63 percent of those institutions’ book values.

Why should we care about European banks?  Quite simply because many of them have a large presence here in the US and their difficulties will translate into a reduction in the availability of credit.