New episode in euro Greek drama rattles world markets

— -- On Wall Street, event risk means an unforeseen development that sends markets reeling. The markets were full of event risk Tuesday.

The event: Greek Prime Minister George Papandreou announced Monday night that he would call a national vote on the European bailout package agreed to last week. Polls show the vote would be unlikely to pass. "This would undo all the progress made to date," says Alec Young, global equity strategist for S&P Capital IQ.

The move raised the possibility of a full-blown Greek default that could topple the finances of other countries, unravel the eurozone, and send the world into recession.

Then again: Perhaps not, if Greece and its European partners can cobble together a solution to the Greek debt crisis. But it could be a long, nail-biting process.

"We're going to continue to see really shaky markets, constantly torn between hope and despair," says Scott Mather, managing director at Pimco.

Despair ruled the day Tuesday. The Dow Jones industrial average dropped 297 points, or 2.5%, closing at 11,658. The German DAX index tumbled 5%, and Britain's FTSE plunged 6.8%. The value of the euro fell on international currency markets, and investors desperate for safety pushed down the yield on the benchmark 10-year U.S. Treasury note to 1.96%.

The market's violent reaction to the news is based on "legitimate concerns," says Tim Anderson, chief fixed-income strategist at Riverfront Investment Group. How those concerns evolved:

•Greece, racked by recession and plagued by overzealous spending and underzealous tax collection, asked for a European Union and International Monetary fund bailout in April 2010.

•In June this year, rioting broke out in Athens as the government announced new cutbacks to allow the next batch of rescue loans.

•Last month, tensions again arose as the possibility of a Greek default loomed again. Eurozone leaders and the IMF crafted a package that would allow Greece to pay 50 cents on the dollar on some of its debt. The agreement also proposed a 1 trillion euro fund to shore up Greek and other troubled eurozone countries, such as Italy, Spain and Portugal. And European banks would be forced to raise capital — the money they use to cushion losses.

Stock markets in Europe and the U.S. soared on the news. But investors became increasingly concerned that the plan raises more questions than it answers and that further reforms would be needed, Anderson says. Among those questions: Where, exactly, would that 1 trillion euros come from? "They were going to have to go hat in hand to the Japanese and Chinese," Young says.

Papandreou's surprise call for a Greek national referendum put the entire deal on hold and sent shudders throughout the financial markets. It's unlikely, after all, that anyone would contribute to the proposed 1 trillion stabilization fund if Greece defaults.

More important, a hard Greek default — where the country doesn't pay any of its debts — could have catastrophic consequences. Not only could some large holders of Greek debt go under, but confidence in all the troubled eurozone countries would be shaken.

Greece could be kicked out of the eurozone — or could leave it voluntarily, which would allow the country to pay its debts with newly minted drachmas, which would be heavily discounted on the world currency markets.