Felix culpa

Greece: A Greek government default need not doom the euro project. Well managed writedowns could even make the single currency stronger. Default talk was getting louder even before Standard & Poor's downgraded its rating on Greek sovereign debt to junk on April 27. The numbers are scary. Although the country can probably hang on for a while, with help from the International Monetary Fund and probably the European Union, European authorities should be planning for a bad scenario.

Without adequate preparations, a Greek default could potentially start a financial avalanche. Panicked investors would flee the debt of other weak countries, bringing a series of crises and defaults - and creating huge losses for the European Central Bank, which holds sovereign debt as collateral. Solvent member governments might refuse the central bank's requests for help. Defaulted countries could be expelled from the euro zone and strong countries might just quit.

But none of this needs to happen.

In the euro zone, Greece really is in a class of its own in terms of financial and economic mismanagement, current debt and deficit levels and political discord. Contagion can be avoided with strong austerity policies from the zone’s fiscally strained members. And even if every euro cent of Greek sovereign debt has to be written off, the total loss to the European financial system would be around ¤300 billion a manageable amount by current standards.

Of course, a member default would change the way the currency union works. At first, there would be many nail-biting moments as the central bank and the member governments squabbled over how to apportion losses and struggled to keep alive any vulnerable banks, in Greece or elsewhere. The technical, legal and political challenges would be significant, but not insurmountable.

Longer term, though, the recognition that default is always possible should be a positive. The ECB would have to be less cavalier about accepting dodgy government debt as collateral — which would put healthy pressure on governments. Private lenders would also be more careful. And the market would bar Greece from borrowing until it was likely to be able to repay.