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Averting a Disorderly Greek Default

Author: Christopher Alessi
January 18, 2012

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Representatives of the European Union, the European Central Bank, and the International Monetary Fund--the so-called lending troika--arrived in Athens this week to assess the Greek government's progress (DeutscheWelle) in implementing strict budgetary measures to rein in its high public debt. The visit comes days after negotiations broke down between the government and its private creditors over a "voluntary" debt write-down, part of a second EU-IMF financial rescue package negotiated last year. At the same time, credit rating agency Standard and Poor's downgraded nine eurozone countries--toppling France's prized triple-A rating--and the temporary European Financial Stability Facility, further exacerbating the ongoing eurozone sovereign debt crisis.

What's at Stake

Political leaders and market actors alike are increasingly concerned about an involuntary or disorderly Greek default. These fears have risen in the wake of Athens' inability to reach an agreement with private creditors over the debt haircut, and mounting evidence that Prime Minister Lucas Papademos has failed to implement promised structural economic changes. In such an instance--which could occur as soon as March if the troika decides to withhold the next tranche of bailout funds--Greece would lack the resources to meet its debt obligations and simply stop paying its creditors, potentially devastating Europe's financial institutions. A disorderly default would not only threaten to unravel the single currency union, but "could unleash violent market reactions" (NYT) throughout the global economy, spurring a new world recession.

The Debate

Many economists and analysts say that the strict fiscal austerity Germany has mandated for debt-laden eurozone states like Greece is too narrow an approach to salvage the euro, and will ultimately backfire.

"Austerity as the solution is just wrong," economist Joseph Stiglitz told Bloomberg. "There won't be a return to confidence--quite the contrary," he said. While TIME's Michael Schuman writes, "The more budgets get cut and taxes go up, the weaker economies become. That makes it harder to meet fiscal targets or stabilize debt, leading to more cutting and tax hikes and even slower growth."

Policy Options

With an $18 billion Greek bond redemption approaching on March 20, the ECB should help facilitate Greece's voluntary restructuring by alleviating the concerns of private creditors, a Financial Times editorial argues. The ECB "should be asked to sell its Greek bonds--at their purchase price--to the eurozone's rescue fund, which could swap them into a direct loan to Athens before PSI [private sector involvement] is carried out," it says.

More broadly, Gideon Rachman says, as the United States did with the Marshall Plan after World War II, Germany and other wealthy EU states should make bolder financial sacrifices (FT) to save Greece and preserve the eurozone. "In 1947, when a conflagration in Greece was threatening the world, the fire trucks set off from Washington. In 2012, they are being sent from Berlin and Brussels--late and underequipped," Rachman notes.

Background Materials

The eurozone is buffeted by a sovereign debt crisis of nations whose membership in the currency union has been poorly policed, explains this CFR Backgrounder.

Over the past two years, U.S.-based credit rating agencies have come under intense criticism by EU officials, who contend the raters have accelerated the European sovereign debt crisis, explains this CFR Backgrounder.

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