Advancing a Free Society

When Greece Defaults

Friday, July 8, 2011

Although the Greek Parliament scraped the votes together to pass another round of austerity measures last week, there is a very high likelihood that in the next 12 months Greece will either jump or be pushed into default on its debts.  There are five principal reasons to be skeptical Greece can continue to navigate the space between European Monetary Union support and financial markets concern about their creditworthiness:

  1. The government doesn’t have support of opposition parties for continued austerity of the magnitude that would be required -- probably for decades -- to keep the terms of Greece’s deal with the IMF, European Central Bank, and Euro countries.  The opposition voted against the austerity package, and its leader, Antonis Samaras, has publicly called the austerity program a failure.  The government could be forced to elections as early as autumn, which polls suggest the opposition might win.  This would lead to Greece taking growth-spurring strategies like tax cuts that its counterparties will not support.
  2. Private holders of Greek debt won’t play ball.  Germany has proposed private holders “voluntarily” roll over debt as a condition for the government providing bail out money.  But the European Central Bank has warned that private investors exposed to Greek debt will not voluntarily accept roll overs which had been expected to provide 20-30% of the cash.
  3. Ratings agencies aren’t buying the sales pitch, either. Standard & Poor’s concluded the German proposal to force private investors to share in the haircut EU governments are accepting on Greek bonds would constitute a default.  Moody’s has further downgraded Portuguese debt on the basis of the EU’s behavior.
  4. The EU’s reaction to ratings agencies flag is to bewail those organizations, not to bring their political choices into a creditworthy frame of reference.  The European Commission rebuked the agencies for inappropriate behavior; its President, Manuel Barroso, attempted to discredit the ratings agencies by pointing out none of them are based in Europe; the German Finance Minister, Wolfgang Schaeuble, threatened to “break the oligopoly of the ratings agencies” to reduce their influence.  This is hardly the kind of behavior by political leaders that will convince markets they are hearing the signals markets are sending.
  5. Governments have bailout fatigue.  Finland will only approve more money if Greece puts up collateral.  Germany whispers their constitutional court won’t permit transfers, tries to bully investors into “voluntary” give backs.  With Portugal and Spain teetering on the brink of default, too, leaders of Europe’s thriftier countries may soon be persuaded to redirect their attention to protecting others when Greece fails rather than saving Greece.  Euro-wonks already have a new term for it: ring fencing.  It means shoring up banks and governments that will be affected when Greece defaults.
  6. Greece desperately needs to devalue -- a monetary option unavailable to them within the Euro -- in order to regain competitiveness, which is their only medium-term way out of this debacle.

The EU’s leaders are still talking as though Greece defaulting is an impossibility.  But the rapid pace and large scale of a bail out needed to startle markets into taking European leaders seriously is at enormous variance with the slow unfolding of politicians’ willingness to acknowledge the magnitude and nature of the problem.  The stately pace of Europe’s deliberations has already probably quadrupled the size of bailout that would be needed, and political willingness is declining not increasing.  Whether Greece gets shoved by the timing and domestic politics of EU leaders or jumps to gain the benefit of devaluation, it will likely not be able to pull together the domestic and EU political will to continue on its current path.

(photo credit: Luis Miguel Justino)