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No Pause in Greek Debt Drama

Author: Robert McMahon, Managing Editor
Updated: June 30, 2011


The embattled Greek government has survived a vote of no confidence in parliament and won back-to-back votes approving its tough $40 billion austerity plan (WSJ) in the same chamber. These mark major steps toward receiving a $17 billion package of emergency loans by the middle of July and avoiding what would be the eurozone's first sovereign default. Details on a larger international bailout to provide financing through 2014 could come this weekend in a meeting of eurozone ministers.

The news from June 29-30 was treated with relief in U.S. and European markets, which fear the impact a Greek default would have on countries and financial institutions heavily invested in Greek debt. A default could severely affect other weak economies on the eurozone periphery, including Ireland and Portugal, which have also received international bailouts, and potentially threaten the viability of the seventeen-nation eurozone. There is exposure in the United States as well. For instance, millions of Americans hold money market funds, which have loaned money to European banks that have loans to Greece (Bloomberg). And though a number of analysts say threats to money market funds (CSMonitor) are overblown, others cite the 2008 collapse of U.S. firm Lehman Brothers, which contributed to a freeze in interbank lending, upheaval in markets, and showed even money market funds were not risk-free. "If other countries are drawn in [to the Greek debt crisis] through contagion, it could be bigger than Lehman" (Reuters), Josef Ackermann, the chief of Deutsche Bank, said on the eve of the Greek parliament vote.

While the vote was welcomed in financial venues, the air of crisis has not lifted in Europe. The options for a sustainable path forward for Greece to wind down its massive debt appear slim. Some experts believe Greece will still have to default. Two analysts from Commerzbank said concerns would persist (NYT) "if no broader consensus across Greek political parties forms" on economic reforms.

A big reason for general unease is the scale of Greece's problems. Its debt is estimated around $480 billion, close to 150 percent of GDP. As a Bloomberg editorial notes, even in the event of a second bailout and economic recovery for Greece, the government would have to run a budget surplus "of 5 percent of GDP for about three decades to bring down debt to the 60 percent [of GDP] maximum allowed by euro-area rules"--an extremely rare feat. CFR's Sebastian Mallaby cites the complications posed by Greece's large current-account deficit and the fact that Athens compiles more debt from foreigners as long as this deficit persists. To stop running such a deficit, he writes, "Greece must become more competitive. Since exchange-rate adjustment is impossible for a country with the euro, the depreciation has to come in the form of falling wages and prices. That is not only politically implausible. It would also boost the real value of Greece's debt and compound the core problem."

What to do? Writing in the Financial Times, analyst Jean Pisani-Ferry cites "only two economically consistent options." Plan A, he writes, "is to socialize the Greek debt. It requires lowering the interest rate on official assistance to a level that makes Greece solvent and deciding who, if needed, will bear the corresponding cost--either the banks, through a special levy or, by default, the ordinary taxpayers. Plan B is to make private creditors pay through an orderly restructuring."

Meanwhile, a French proposal gaining attention has private bondholders reinvesting half of the proceeds of maturing Greek debt in new thirty-year bonds. The plan encourages private-sector participation (DerSpiegel) and provides government backing in the event of a Greek default. German officials have said it could provide a basis for discussions on the second Greek bailout package, but a number of analysts quoted by the Wall Street Journal said the conditions only add further burdens for Greece and simply delay its day of reckoning.

Selected Analysis:

The Greek crisis is relevant for other European nations with high debt-to-GDP ratios--like Italy, Belgium, and Spain--and it highlights problems with Europe's "less-than-healthy banking system," writes Heather Conley, a senior fellow at the Center for Strategic and International Studies.

EU bailout funds should be expanded and given powers to buy bonds in financial markets, which would "send a much-needed signal that member countries 'will do whatever it takes to safeguard the stability of the euro area'," the IMF says in a new report on the eurozone.

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