Greece’s second rescue package is now proceeding apace. After a meeting in Berlin, the leaders of Europe’s two most viable economies, Germany’s Angela Merkel and France’s Nicolas Sarkozy, have resolved one of the principal disputes surrounding the new bailout: private bondholders will not be forced to participate, but may do so on a voluntary basis. This action follows Greek Prime Minister George Papandreou’s cabinet shake-up last Friday, which resulted in the replacement of his finance minister with a Socialist Party colleague capable of delivering the votes necessary to pass the latest austerity package, even as rank-and-file Greeks despise the latest combination of higher taxes, budget cuts and the sale of government-owned assets.
“The country must be saved and will be saved,” said new Greek Finance Minister Evangelos Venizelos, whose own track record of financial acumen is questionable. From 2001-2004, he was in charge of getting Athens ready for the Olympic Games, and the $15 billion spent did less than expected to modernize Greece’s post-game infrastructure. Yet it is likely that Mr. Venizelos’s financial qualifications are a side issue. As a loyal member of the same Pan-Hellenic Socialist Movement (Pasok) party as Prime Minister Papandreou, as well as being Papandreou’s chief rival during the 2004 general election, Mr. Venizelos’s support of the latest package is critical within a party where the defection of only six members could derail approval of the additional funding and/or the current government itself.
According to Jose Vinals, director of the monetary and capital markets department of the International Monetary Fund (IMF), any action taken by Greece as well as other countries mired in government debt (including the United States), must occur sooner, rather than later. “You cannot afford to have a world economy where these important decisions are postponed because you’re really playing with fire,” said Vinals. “We have now entered very clearly into a new phase which is, I would say, the political phase of the crisis.”
Thus, Germany and France have come together, despite Germany’s original insistence that the banks and other private creditors holding Greek debt incur losses as part of the new rescue plan. This was a natural reaction by Merkel to the German public’s well-publicized disdain for underwriting Greek profligacy. Merkel herself expressed that disdain to German national news agency DPA on May 18th. “It’s not about whether people in Greece, Spain, Portugal can’t retire earlier than in Germany, it’s about everyone pulling their weight equally. We can’t have one currency, and one gets a lot of vacation and the other very little.”
The French, on the other hand, are ostensibly more pragmatic. “France is a Latin country that feels closer to the Greeks,“ said Philippe Moreau-Defarge, researcher at the French Institute of International Relations. “They also feel it could happen to them,” he added. A survey by the Greek newspaper Ethnos taken in March last year, bears this out: 69.6 percent of French respondents are willing to help Greece, while only 2.7 percent of Germans feel the same way.
Yet such pragmatism may be buttressed by the sobering reality that no other developed country has incurred greater risk with respect to a Greek default than France. French bank exposure is $56.7 billion, versus $33.97 billion for German banks, and last Wednesday, Moody’s Investment Service warned that the country’s three largest banks, BNP Paribas SA, Société Générale SA, and Crédit Agricole SA, may be facing a ratings downgrade. This follows Standard & Poor’s lowering of Greece’s credit rating to CCC, as there is ”a significantly higher likelihood of one or more defaults,” the agency said in a statement released on June 13th.
A briefing paper circulated by the European Commission reviewed by the Financial Times proposed three options for dealing with Greek debt. One would have been a voluntary debt exchange, which would extend the maturity date on Greek government bonds, giving Athens more time to repair its debt crisis. German finance minister Wolfgang Schäuble suggested a seven-year extension, which was completely rejected by the European Central Bank (ECB) and France, due to the fact that such a move would likely be considered a “structural default.“ Andrew Bosomworth, head of Munich portfolio management at Pimco explained. “An extension of the maturities will not solve Greece’s income and debt imbalances. It will leave the country’s debt stock unchanged and thus the reluctance of the market to buy into the IMF/EU debt program will not change,” he said.
Options two and three involved a voluntary rollover of current bonds, which was seen as less likely to trigger a ratings downgrade. The first rollover would be a coordinated one, likely organized by the Greek government, and designed to encourage the greatest level of private participation, while the second would be an informal rollover, which would likely keep most private investors on the sidelines.
Thus, France and Germany have agreed to make any private participation voluntary without a clear indication of whether option two or option three is the preferred choice. This was reflected in the reality that even this latest package, characterized as a “breakthrough” by Mr. Sarkozy, must still be approved by the ECB and win the favor of private creditors, a process likely to take several weeks. And the lack of clarity remains troubling. “Under certain conditions, a rollover could be viewed as not truly voluntary by the rating agencies and therefore subject to selective default,” wrote Gavan Nolan, director of credit research at Markit. “Getting the balance right between enticing participation at a cost that is reasonable will be difficult,” he added.
Yet Bob Doll, chief equity strategist at BlackRock, gives light to a different perspective. ”We’re going to find Band-Aids and we’re going to muddle through these credit problems,” Doll said. “The consequences of not following that route could be pretty dire, and I think the interested vested parties are going to step up.”
Yet most economists remain unconvinced. Greece’s current debt amounts to 340 billion euros ($485 billion), which is 150 percent of the country’s annual economic output. Calculations by Reuters, based on 5-year credit default swap prices from Markit, show an 81 percent probability of Greece eventually defaulting, based on a 40 percent recovery rate. Then there is Greece itself, which must pass any austerity package agreed upon if Europe is to be spared what many nervous bankers have referred to as a “Lehman type moment,” harking back to the 2008 collapse of Lehman Brothers which sparked the current Great Recession.
It is an austerity package which promises to be even more severe than the one which precipitated several riots in that country, including the ones last Wednesday in Athens, where tens of thousands of angry Greeks massed around the main Syntagma Square to protest. Some of the rioters hurled gasoline bombs at the Finance Ministry, and police responded with tear gas. And while “Band-Aids” appear to be the order of the day, they may only be deferring the inevitable. Economic professor Nouriel Roubini illuminates why. “The muddle-through approach to the eurozone crisis has failed to resolve the fundamental problems of economic and competitiveness divergence within the union,” he said. What he means is elucidated by investment banker Martin O. Hutchinson. “Greece produced nothing close to the level of economic output that would be needed to justify its spending and the lifestyle of its people…Its people need to suffer a decline in living standards of about 30% to 40% so that the country’s output is sufficient to repay its debts,” he echoed.
Greece is not alone. Last Friday, after European markets had closed for the weekend, Moody’s placed Italy’s Aa2 rating on review for possible downgrade during the next 90 days, due to “structural weaknesses such as a rigid labor market [which] posed a challenge to growth,” reinforcing the notion that the Greek debt crisis is “contagious.”
Such contagion has not gone unnoticed in the United States. Also on Friday, four Senators, Jim DeMint (R-SC), Orrin Hatch (R-UT), David Vitter (R-LA) and John Cornyn (R-TX) introduced an amendment to the Economic Development Revitalization Act, which would prevent the IMF from accessing $108 billion of U.S. taxpayer funding sanctioned by the Obama administration in 2009 to bail out foreign nations. “Now is not the time, when Americans are struggling to find work and have budget problems of their own, to tap innocent American taxpayers in order to bail out profligate European governments,” said Hatch in a released statement.
This is an obvious attempt to insulate the United State from a eurozone suffering through a string of related defaults. And America is not alone in in that respect. According to “senior sources,” British banks, including Barclays and Standard Chartered, have radically reduced the amount of funding available for unsecured lending to other eurozone banks, withdrawing tens of billions of pounds from the inter-bank markets. The move threatens to seize up credit markets in a scenario similar to 2008, when stronger banks refused to lend to weaker ones, which led to a string of major banks going under–and taxpayer bailouts for those that didn’t.
Where is all of this headed? A brilliant speech given last Thursday by Lorenzo Bini Smaghi, member of the executive board of the ECB, at the Executive Summit on Ethics for the Business World explains some of the current thinking:
The fight to survive, which in a capitalist system should reward the company with the best product, is changing in nature. Particularly in a period of economic difficulty, when returns are limited, those who survive are those who bet on the failure of others and who manage to convince the market that such a failure is inevitable. It is no longer about Schumpeter’s ‘creative destruction,’ but ‘destructive destruction,’ where the one who survives is the one who bets, rather than the one who innovates and produces.
“The same is true for countries,” he said.
Next week, the Greek parliament will vote on the latest series of austerity measures, which include $39.5 billion of taxes and budget cuts, along with a privatization drive valued at $70 billion–all of which is required by the IMF before it will release the next $17 billion installment from the original bailout package. The government has also promised to cut 150,000 jobs from its over-loaded public sector workforce by 2015, effectively ending the long-cherished concept of lifetime government employment in the process. All of it will be thoroughly despised by Greeks who, to paraphrase Margaret Thatcher, have yet to comprehend that the inevitable demise of their socialist society comes because Greece is running out of French and German money to spend. The vote is scheduled to take place at midnight on Tuesday.
For a eurozone faced with the real possibility of dissolution if the vote goes the wrong way, it’s even later than that.
Arnold Ahlert is a contributing columnist to the conservative website JewishWorldReview.com.