Here's What Really Matters When Greece Defaults

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The sands of time are ticking against Greece. We are no longer talking about if the indebted country will default on its debt, but simply when.

A few days ago, credit rating agency Fitch essentially called Greece insolvent and noted that it would probably not be able to meet a March 20 bond payment of approximately $18 billion. The Eurozone nations have been working feverishly to find a solution to Greece's debt woes but have been held up by either Greece itself or the participation of other EU countries.

Luckily for the EU and the world, a Greece default is in itself relatively meaningless. Speculation is running rampant as to what will and won't be important when the country finally does drop the ball, so I thought I'd take the time here to throw in my two cents on the subject.

What's not important: The actual Greek default.
A Greek default has been a foregone conclusion since late last year and it's not really a surprise, seeing as how Fitch currently has the country rated a CCC -- one grade above default. Current two-year bond rates in Greece are yielding a mind-numbing 172% and have been as high as 206%. These figures make no mistake that Greece is on the precipice of default.

What is important: The type of default.
Admittedly Greece is a small fry when it comes to annual GDP, but the method by which Greece defaults is important. It's much postulated that Greece will partially default on roughly $100 billion of its $205 billion in privately held debt. This would allow the country to save in the neighborhood of $4 billion in debt-serving costs annually, with the hope that it can get its debt-to-GDP ratio down to 120% by 2020. This type of default is already being factored in by the market. Anything larger than $100 billion could stymie the U.S. stock market rally and crush the financials.

What's not important: U.S. money-center banks' exposure to Greece.
If we've learned anything from large U.S. banks, it's that they can absorb pretty substantial losses without too much trouble. Bank of America (NYS: BAC) absorbed an $8.8 billion quarterly loss related to its mortgage mess originating from Countrywide Financial and it's still profitable for the year (though just barely). JPMorgan Chase (NYS: JPM) CEO Jamie Dimon described his bank's exposure to Greece as "nearly zero" back in June, while Greek debt hasn't even appeared on Goldman Sachs' (NYS: GS) or Citigroup's (NYS: C) quarterly reports for the past few quarters.

What is important: U.S. money-center banks' exposure to everyone else.
The really tricky thing here is how to negotiate an organized Greek default without enticing the other troubled nations -- Ireland, Portugal, Italy and Spain -- to do the same thing. If the EU makes it too easy for Greece to default, then the others are likely to follow. However, if the EU takes a hardline stance with Greece, the other nations are likely to note this and continue to make their debt payments. Beyond Greece, JPMorgan Chase and Citigroup have very significant loan risks. Citigroup is currently on the hook for $12.3 billion to Italy and $10.8 billion to Spain, while JPMorgan Chase has lent $18.8 billion to Ireland, $12.2 billion to Italy, and $12 billion to Spain. These are not absorbable chunks of change.

What's not important: How Greece got into debt.
I know this is controversial, but I believe it really doesn't matter how Greece got into this mess. Unfortunately, we do know that a burst housing bubble and a gross misrepresentation of borrowings by former Greek leaders were a big part of Greece's debt woes. But reflecting on the past isn't going to change the present situation.

What is important: Making sure this doesn't happen again.
What the EU does need to focus on is how to get Greece back on the right track. It's brutally apparent that Greece needs to reduce its spending through some fairly deep austerity measures, but that alone, unfortunately, will not allow it to get out of its prolonged recession. It therefore seems almost inevitable that Greek debtors will need to take a debt haircut just to allow Greece to get back on its feet. Once they're standing again, however, it seems logical to me that strict spending limits to GDP need to be imposed and everyone needs to figure out a way to lower Greece's ridiculously high unemployment rate, which currently sits at 18.8%.

Foolish roundup
If you take anything from what I've said above, it should be that a Greece default itself won't be detrimental to the EU, but the nature of the default and how the EU negotiates with Greece during and after its default will likely determine the direction the EU is headed over the next six to 12 months.

What's your take on Greece's ongoing soap opera with the EU? Share your thoughts in the comments section below.

Also, if you want to worry less about your investments, then I invite you to download a copy of our latest report, "3 American Companies Set to Dominate the World." It highlights three companies that are trouncing the competition in the emerging markets and are likely to be little affected by a Greek default. Best of all, this report is completely free for a limited time, so don't miss out!

At the time this article was published Fool contributorSean Williamsowns shares of Bank of America, but has no material interest in any other companies mentioned in this article. He can't fathom the idea of nearly one in five people out of work. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase.Motley Fool newsletter serviceshave recommended buying shares of Goldman Sachs. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policythat always puts its readers' interests first.

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