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In a race against time

May 2nd, 2010 · No Comments

Some time has been won with what seems like a ‘massive attack’..
Between a rock and a hard place and having dithered for months about a much smaller contribution, it now seems like the Germans have agreed to a large scale bail-out of Greece. Because of developments in the financial markets, Greece didn’t have access anymore so it’s now totally dependent on the EU and the IMF.

Germans balked at having to fork out 8.4B euro (their 28% share of a 30B euro EU rescue package, topped by 15B euro from the IMF) for months. That amount has now grown to between 18.7B and 22.4B euro (depending whether the total aid package is 100 or 120B euro). The rest of Europe has to fork out 2/3 (minus the 28% German share) of that total aid package and do so unanimously. The rest (1/3) is financed by the IMF.

In exchange, the Greek will embark on unprecedented austerity measures to the tune of 30B euros, or 13% of Greek GDP. What this will do to their already shrinking economy is not hard to guess:

  • “There is a very real possibility that at the end of two or three years, Greece will still have an unsustainable debt and will have to restructure because it will have a deep, deep recession in the meantime,” said Barry Eichengreen, economics professor at the University of California, Berkeley.[Bloomberg]

And that’s even provided they manage to implement these measures in the rather volatile Greek political environment.

Some observations:

  1. Europe did at least rise to the challenge, the large bail-out was by no means a foregone conclusion even a week ago
  2. It buys time. One reason the package was agreed upon is that people hope the Greek situation will stabilize after a while, allowing Greece to return to the markets and not needing the 3 year bail-out (it will be paid in tranches)
  3. The EU didn’t have any immediate choice. Without this massive bail-out, markets would have been in turmoil Monday morning
  4. Instead, a relief rally will be likely (like we argued before)
  5. We still think there are many ways this whole trajectory can derail. In Greece itself: by political opposition and/or street protest and resulting chaos, and by the sheer weight of the Greek economic problem, which can only worsen in the near time
  6. Political opposition elsewhere in the EU is another possibility, especially if (as seems likely), the Greek situation will only worsen near term, and other European nations might experience similar problems.
  7. Other EU countries also have to embark on unprecedented austerity to stave off unsustainable public finance situations (and market speculation against them). The collective weight of this could easily derail the economic recovery and thereby make deficit and debt reduction that much more difficult.
  8. Markets could start attacking the weakest countries again when, as we belief, the short-term situation will only worsen. These attacks come mostly from the credit default swaps (CDS’s), an obscure insurance against sovereign default. These rather illiquid markets are one of the main (if not the main) driving forces of interest rates on public debt in countries like Greece and Portugal. Portugal has twice the amount of outstanding CDS’s compared to Greece.
  9. In case the Greek crisis cannot be contained or if it spreads to other countries, we think it’s unlikely a rescue package of the size of Greece’s can be repeated.
  10. We think an alternative, restructuring Greek debt, using the funds now on the table for the Greek bail-out for insulating European banks from the consequences (less than half is needed to do that), and possibly remove Greece from the euro is a cheaper and better option (both for Greece and the EU itself), with the one distinct disadvantage that it’s not implementable before the markets open on Monday morning and a restructuring of Greek debt could very well trigger a bondmarket crash in other European countries.
  11. So, basically, Europe didn’t have an option, but that doesn’t mean the policies are the best. Like we argued before, this problem is not going to go away anytime soon. After a (brief?) respite, we think things might get worse before they get better.
  12. One a positive note though, Greece now has the opportunity to get its economy in order for the long-time, the measures now being suggested would hardly have been thinkable, let alone possible, during normal times. It’s true what they say, every crisis provides an opportunity…

Tags: Sovereign debt crisis