by Michael Schuman
The entire financial world was watching Athens today to see whether or not the Greek government would survive a no-confidence vote. Thankfully, it did. More importantly, the government now has to push a new slate of severe austerity measures through parliament next week to try to control its escalating debt. If the package gets rejected, further bailout funds may not flow, and Greece would rapidly spiral towards a default with bond payments coming due next month. That would also probably dash Greek hopes for a second bailout, currently being debated by the leaders of the euro zone. So a lot is riding on next week's vote in Athens – the Greeks economic future, the direction of the European debt crisis, and perhaps even the viability of the monetary union.
But despite all of the potential consequences, I've come to believe that further bailouts for Greece are just plain idiotic, for everyone involved – creditors, the euro zone, or the Greeks. Here's why:
First, the bailouts are not actually making it any more likely that Greece will be able to pay its debts back. Perhaps just the opposite. The bailouts are trying to solve Greece's debt problem with debt. The talk is that a proposed second EU bailout could total as much as 120 billion euros. Taken together with last year's 110 billion-euro rescue, the combined bailouts could add up to a remarkable 100% of GDP. With mandated budget cuts, tax hikes and other austerity measures eating into the country's growth potential, the combination of a stagnant economy and unresolved high debt levels is not going to convince any investor to trust his or her money with the government in Athens.
That's especially because no one can trust Athens to follow through on its reform pledges. Even if the austerity package passes parliament on Tuesday, is it politically possible to implement it? Will politicians eventually cave to anger on the streets? Can the government even survive in the face of such opposition? There is no way investors can be convinced that the government in Athens will hold up its side of the bargain, and thus no way to convince private investors to have faith in further EU bailouts. In fact, continued EU aid may actually be undercutting Greek reform efforts rather than energizing them. In a very interesting analysis of the Greek political situation in The Wall Street Journal, Takis Michas makes the point that those political forces that gain from resisting EU-mandated austerity programs – public sector unions and opposition parties – have no incentive to join in reform since they believe the EU will continue to bail out Greece under any circumstances to protect its creditors. In other words, as long as the Greeks know the gravy train is coming, they have less reason to accept reform.
So this all leads us to another reason a second Greek bailout is idiotic. If creditors will continue to have doubts about Greece's ability to reform and pay them back, then the new bailout scheme simply can't work. At the insistence of the European Central Bank, the new bailout is based on the assumption is that bondholders will “voluntarily” choose to participate in a debt rollover -- to reinvest their money in new, long-term Greek bonds when their original holdings come due. But without confidence in the Greek economy, what sane person would choose to take on long-term Greek debt? Maybe big European commercial banks will “volunteer,” to put off carving a hole in their balance sheets, or due to pressure from political authorities. But everyone else? An insightful story in The Financial Times quoted Gary Jenkins, head of fixed income at Evolution Securities, as saying: “I can't see why anybody would want to roll over a Greek bond if they had a choice. I can't see private investment funds being willing to do this.” So without private sector support, the entire bailout scheme crumbles, and we're looking at a possible default at some point in the future anyway.
Or more bailouts. The EU's solution to Greece's problems is effectively substituting privately held debt for publicly held debt. But is that sustainable? Not really. Greece needs to woo back private investors, but the current bailout system is not making that happen. That means Greece either defaults or becomes a perpetual welfare recipient. But the latter option will not be politically acceptable in Europe. At some point voters and their representatives in countries forced to foot the bill, like Germany and France, are going to say enough is enough and refuse to continue funding Athens.
And then what? However you slice it and dice it, Greece's debt is unsustainable, and the bailout process being employed to fix the problem is equally unsustainable. So let's just stop wasting everybody's time and restructure Greece's existing debt. That would achieve various ends. A debt restructuring will adjust the Greek debt load in a way that gives the government more time to reform, eases the immediate pain to the economy and improves the chances the economy can return to growth. That doesn't mean the Greeks will be let off the hook – painful austerity and public-sector reform are unavoidable under any scenario. But a restructuring would make the reform process more politically palatable in Greece, and thus make it more likely that Greece will be able to pay back its remaining debt. In other words, a debt restructuring will begin the process of restoring confidence in the Greek economy.
What of contagion fears? Well, whether we have an ill-conceived second bailout that no one believes will work or a restructuring/default, we'll be looking at contagion to other weak euro zone economies. At least a restructuring would clear up the uncertainty hanging over European bond markets. And creditors should take their lumps. Anyone silly enough to give the Greeks their money, knowing the state of its feeble finances, deserves to lose out. Perhaps some financial institutions will take a hit, especially Greek banks, which may require a bailout of their own if losses got too big. But a one-off recapitalization of some banks is better than keeping Greece on life support indefinitely. And with private sector creditors finally participating in resolving the euro debt crisis, politicians in Berlin and Paris will have an easier time justifying helping out Greece with more aid if necessary.
And what do we lose with a debt restructuring? Investors would put more pressure on the other bailed-out economies of the euro zone – Portugal and Ireland – as well as on Spain, fearing they could get hit with further losses on those nations' bonds. Perhaps, then, a Greek debt restructuring may make it more likely that other euro zone countries will need further bailouts or worse. But borrowing costs for these countries have been going up anyway due to the uncertainty surrounding Greece, while the reform of these weak economies has to speed along whatever happens in Athens.
So it's time the leaders of Europe bow to the inevitable, restructure Greek debt and deal with the fallout. Is there any other way?
