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By Jason Stipp | 04-27-2010 12:35 PM

What Do the European Credit Woes Mean for Investors?

Morningstar markets editor Jeremy Glaser sizes up the situation today and the best and worst scenarios.

Jason Stipp: I'm Jason Stipp for Morningstar. Continued trouble in Greece and the Eurozone rocked the markets on Tuesday, on the heels of some sovereign credit downgrades.

Here with me to talk about the situation, and what it means for investors, is Morningstar Markets Editor, Jeremy Glaser. Jeremy, thanks for joining me.

Jeremy Glaser: You're welcome.

Stipp: So the situation, it seems like day after day you read that the situation has been improving. And then you read, oh, it's had a step back. And now, it seems like it's had a major step back. What exactly is going on with the Greece crisis, and the other countries, that are in trouble over there?

Glaser: You're right, Jason, there's been a lot of fits and starts in solving the Greece debt crisis. In the last couple of days, it seems to have gotten a lot worse. First, we found out that the budget deficit that the Greek government had estimated is actually going to be much worse than they first thought.

That the austerity measures that they put into place haven't really made a big impact in the amount of debt that the government has. Investors have gotten really scared, and the spread between a Greek bond and, say, a safer German bond have continued to widen and widen and widen.

People aren't convinced that the Eurozone and IMF joint bailout is going to make a big difference. No one knows exactly when that money's going to hit. There's some political problems with exactly how the European Union can actually do this bailout. So I think until people see that money, they're going to be scared of Greek debt.

We saw S&P downgrade Greek debt to junk status. But they also downgraded Portugal's debt a notch, which shows that there's a lot of fear that this contagion -- that this idea that we're going to have problems with Greek debt -- is starting to spread to other countries that have high debt levels.

Portugal, Spain, are some that are mentioned most frequently. It's starting to spread very slowly across the continent, and a lot of investors just don't know when it's going to stop.

Stipp: Here in the US, during the trading day today, there was a -- the market really took a dive. So, obviously, US investors -- you never know for sure what's causing it, but it seems like -- they're worried about this too. Is there a direct effect for US investors on what's going on over in Europe?

Glaser: Very narrowly. I don't think there's a huge direct effect with Greece in itself defaulting. I don't think a lot of US investors have much exposure to Greece. It's a pretty small market, so there's not a lot of companies that have -- are selling -- a ton of goods into Greece or getting a lot of exports from the country. I think the biggest problem is what it says about the state of the European economy, which is incredibly important to a lot of American companies.

Stipp: So if you were going to say then, that there's possibly an indirect effect, what things should be on our radars as potential risks here?

Glaser: Yeah, there's a lot of big ones. I think the first one is, just in general, the European economy seems to be recovering at a much slower rate than that of Asia, and other developing markets, and even that of North America. We've seen pretty good growth in other regions, but Europe still seems to lag behind.

GDP growth seems to be lagging a lot of other regions. It seems to be kind of a big problem. If you see countries are having trouble with keeping the currency stable and defaulting on sovereign debt, you're not sure that they're going to be there to continue to stabilize the banking system in Europe, which is much weaker than it is throughout the rest of the world at the moment.

It makes it unclear that they're going to get that growth, they're going to be able to purchase these products, and there's a lot of American companies that have a lot of interest in selling goods to Europeans. So that could be a big problem.

But I think there's a lot of other areas of instability that we could see in Europe. The UK elections that are coming up have a very indeterminate effect. It looks like the Liberal Democrats, who are coming on very strong, could end up in a coalition government with the Tories.

Something we haven't seen here, since the '70s, in UK politics. Who knows what the impact of that could be on monetary and fiscal policy? Who knows what the impact of further defaults, if it spreads from Greece, if it really hits Portugal, if it really hits Ireland, if it really hits Spain?

Those are much bigger economies that could have a much bigger direct effect on the United States. There's just a lot of question marks right now. Investors don't like uncertainly, and I think that has a lot to do with why the sell-off is happening.

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