Greek referendum deflates Eurozone plan, sparks market sell-off

Europe's days-old plan to solve its crippling debt crisis and restore faith in the global economy has been thrown into chaos by the Greek prime minister's stunning decision to call a referendum on the country's latest rescue package.

A 'no' vote could cause a devastating disorderly debt default in Athens that would cause bank failures across Europe, new recessions in the developed world, and see Greece leave the common euro union.

The reaction in the markets was brutal, particularly in Europe, with the Athens exchange down a massive 6.8 per cent on worries the turmoil could bring down the government.

A wave of selling swept Wall Street and stock markets around the world Tuesday.

The Dow Jones industrial average plunged 308 points, or 2.6 per cent, at midday. It sank 276 points the day before. The stocks of major banks, including Citigroup and JPMorgan Chase, were hit the hardest.

Intense selling roiled markets in Europe. Italy's main stock index dropped 6.8 per cent. France's fell 5.4 per cent and Germany's fell 4.9 per cent.

"While it may be the democratic thing to do ... what happen if Greece votes 'no', which is possible given how unpopular the bailout plan appears to be amongst Greece's voters?" said Michael Hewson, analyst at CMC Markets. "The resulting fallout could well result in a complete meltdown of the European banking system and throw Europe into turmoil."

Months of uncertainty over the vote, to be held early next year, would threaten the stability of larger economies like Italy, which saw its borrowing rates rise sharply on Tuesday and would be too expensive to rescue.

The turmoil will also hinder European leaders' efforts to implement their anti-crisis measures, such as getting countries like China to contribute to their expanded bailout fund, and convincing banks to accept bigger losses on their holdings of Greek debt.

German Chancellor Angela Merkel and French President Nicolas Sarkozy agreed to hold emergency talks on Greece with the European Union, the International Monetary Fund and Eurozone leaders on Wednesday. A separate meeting with the Greek government is also planned ahead of the Thursday summit of leaders from the G-20 economic powers in Cannes, France.

"Germany and France jointly with their European partners are determined to guarantee the full and swift implementation of the summit's decisions, which are more necessary today than ever," a statement from Merkel's office said.

Greek Premier George Papandreou shocked investors, as well as his own citizens, party lawmakers and partners in the Eurozone, by announcing late Monday that a plebiscite will be held in what he called "a supreme act of democracy and of patriotism for the people to make their own decision."

A confidence vote in the Socialist government will take place at the end of this week, but it is unclear whether the Socialist government will win it. Papandreou saw his parliamentary majority cut to two seats Tuesday after one lawmaker quit the ruling party, while another two called for him to resign. At least five other Socialist lawmakers last month called for the formation of a cross-party, national unity government.

Given that Greece is heading for its fourth year of recession next year, investors believe there is a real chance Papandreou may lose the referendum vote if it ever takes place. A victory in the referendum, on the other hand, could give the Greek government a solid mandate to pursue its austerity measures required in exchange for the bailout loans.

A recent opinion poll suggested that 60 per cent of Greeks were against the austerity measures that have been required by international creditors from the Eurozone and the IMF in return for crucial bailout loans. However, other polls show broad support for remaining in the Eurozone.

Opposition parties rounded on Papandreou, accusing him of blackmail and vowing to block the vote at all costs, and foreign European officials expressed dismay.

The referendum would be the country's first since 1974, when Greeks voted to get rid of the monarchy, and is expected to be held early next year should the government get through the confidence vote.

The prospect of months of uncertainty has deflated any remnants of optimism over last week's grand European plan to contain the debt crisis.

After long and complex negotiations, Eurozone leaders agreed last Thursday that private holders of Greek bonds should take a 50 per cent loss on their holdings, reducing Greece's debt burden. They also agreed to boost the firepower of the bailout fund to €1 trillion (US$1.37 trillion) and to increase banks capital buffers.