The crisis in the euro zone has lurched into its most dangerous phase yet, putting intense heat on leaders to stabilize Greece quickly, or ensure its exodus does not trigger an economic catastrophe.
Until now, the focus has been on rescuing Greece and saving the 17-member monetary union in its entirety. But Wednesday, Germany's central bank broke a taboo among monetary officials by raising the spectre of Greece leaving. This came amid reports, denied by Greece, that the group's individual finance ministries were drawing up contingency plans.
Heightened fears of a break-up of the euro zone, potentially wrecking the European banking system and plunging the continent into deep recession, pummelled the currency and sent stocks tanking. This came as EU leaders met in Brussels for a summit that, yet again, took on a crisis flavour just two months after Greece accepted €130-billion in fresh bailout loans in exchange for severe austerity commitments.
After a two-day rally, London's FTSE 100 lost 2.5 per cent while the Eurofirst 300, which tracks the performance of Europe's biggest public companies, shed 2.2 per cent. North American stocks recovered lost ground late in the day.
Germany's Bundesbank ratcheted up anxiety about the euro zone's ability to remain intact by warning Greece was in danger of losing bailout loans because it was "threatening not to implement [agreed]reform and consolidation measures" in a period of political limbo.
In its monthly report, the bank went on to raise the possibility of Greece's exit, which would be "manageable" even if the economic consequences would be unpleasant.
Markets were rattled by a flurry of reports that governments were making emergency plans for a Greek exit. Reuters reported euro zone finance ministers, in a conference call Monday, were asked what each is doing to prepare for the consequences of Greece shedding the euro and returning to the drachma.
The news agency quoted an unnamed euro zone official saying that "each euro zone country should prepare a contingency plan, individually, for the potential consequences of a Greek exit from the euro."
The Greek Finance Ministry was quick to deny that. "Such reports not only are not representative of reality but harm the efforts of the country to confront its problems," it said Wednesday afternoon.
But the contingency plan reports were credible. They came less than a day after former Greek prime minister Lucas Papademos told the Wall Street Journal that "it cannot be excluded that preparations are being made to contain the potential consequences of a Geek euro exit."
He later clarified his comments, insisting that he had no specific knowledge of institutions or countries preparing for a euro zone exit.
Making his debut at a crisis summit, new French President François Hollande said "I will do everything I can in my position to convince the Greeks to choose to stay in the euro zone and anything to convince Europeans who might doubt the necessity of keeping Greece in the euro zone."
But Mr. Hollande went into the summit already defeated. Germany had made it clear that euro bonds, heavily promoted by Mr. Hollande and the prime ministers of Italy and Spain, were non-starters. Euro bonds would be backed by the credit ratings of all the euro zone countries, allowing the weakest to raise debt much more cheaply. German Chancellor Angela Merkel has argued such bonds would remove the debt-choked countries' incentive to clean up their fiscal act.
A flurry of research reports from analysts and economists concluded that a Greek exit was almost certain as its economy deteriorates and voters reject the spending cutbacks and tax hikes that have pushed Greece to the brink of economic depression. In the inconclusive general election earlier this month, anti-austerity parties captured about 70 per cent of the vote. Another election is to be held June 17 in an attempt to form a stable coalition government.
In a research note Wednesday, Toronto-Dominion Bank economists predicted Greece will go through another debt overhaul – a debt swap in February erased about €100-billion of its sovereign debt – but also predicted it wouldn't be enough to keep the country within the euro zone.
"If an accident does occur and Greece does leave the euro in the near term, it would have financial ramifications that could range from severe to catastrophic," the report said.
Other economists said a Greek exodus, while painful, would not destroy the European or North American economies.
"A Greek exit on its own might not be a big deal," said a Capital Economics report. "Greece accounts for just 0.3 per cent of world GDP and the rest of the euro zone would arguably be in a stronger position if Greece were to leave. What's more, unlike the sudden collapse of Lehmans, the exit of Greece from the euro would not be a complete surprise."