That Sinking Feeling

The sovereign debt crisis in Europe continues to deepen. Unsurprisingly, the advocates for Greece to restructure its debt (i.e. to partially default) are growing louder:

Furious Greeks press for country to default on debt

A growing chorus of voices is urging the Greek government to restructure its debt as fears grow that a €110bn bailout has failed to rescue the country from the financial abyss and is forcing ordinary people into an era of futile austerity.

"It's better to have a restructuring now … since the situation is going nowhere," said Vasso Papandreou, whose views might be easier to discount were she not head of the Greek parliament's economic affairs committee.

Other members of prime minister George Papandreou's party have said that Greece is locked in a "vicious cycle", unable to dig itself out of crisis with policies that can only deepen recession.

As a result, investors are pushing up interest rates and credit default swap ("CDS") spreads on the debt of the most vulnerable euro countries. Based on this morning's CDS spreads, investors are now predicting a roughly 25% chance of total default by Greece on its sovereign debt either this year or next. If you believe that a partial default is more likely than a total default (e.g. if bondholders are given maybe 50 cents on the dollar for their Greek bonds), then this means that the market is betting that there is a better than even chance that Greece will decide that some sort of debt restructuring is less awful than the alternatives.

As always, though, the big question is this: is Spain really at risk in this contagious debt crisis? An auction of Spanish government bonds this morning was rather troubling -- interest rates on 1-year notes jumped almost 60 basis points. Not good.