Can Europe stomach Greek default? Depends on flavor

Tue Jan 24, 2012 11:29am EST
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By Douwe Miedema

LONDON (Reuters) - The euro zone is inching closer to breaking its long-held taboo against a Greek default, but can still escape financial market mayhem and a body blow to the euro.

It all comes down to whether the default is controlled or chaotic.

Officials have been talking to private bondholders for nearly seven months to get them to share the burden of a second international bailout of Greece with taxpayers, who have so far shouldered all the cost.

But there is still no result, and the threat of a forced default - something that politicians have long been adamant must never happen - drew closer on Monday, when euro zone finance ministers rejected what the banks had billed as their final offer.

Last year, the very prospect filled policymakers with dread but sentiment has changed a little.

Bond markets have thus far exhibited little sense of panic at the slow progress towards a deal, while the European Central Bank wiped out fears over a bank collapse by pumping massive amounts of cash to fund banks into the system in December, an offer it will repeat next month.

The other important shift has come from Paris and Berlin who late last year softened their insistence that private creditors should always take a hit in any future euro zone bailouts. They now say the Greek case is unique and will not be repeated.

Safe-haven German debt futures fell to a one-month low, while Italian bonds - used as a bellwether of sentiment towards the region's lower-rated debt - have rallied, driving yields away from levels deemed unsustainable.   Continued...

<p>A man walks in front of a cafe at Plaka tourist district in Athens January 24, 2012. REUTERS/John Kolesidis</p>