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Saturday, June 25, 2011

EDITORIAL

Greece at a crossroads — again

Greece teeters on the brink of a crisis as its government navigates between demands for austerity by European bankers and politicians and popular outrage prompted by the social costs of those same austerity measures. Although Prime Minister George Papandreou has survived in a vote of confidence, a difficult time for him has not disappeared. Some worry that the future of the euro is at stake as well.

Few elections were as bittersweet as Mr. Papandreou's 2009 win. In retrospect, he appears to have accepted a poisoned chalice when he took office in October 2009, discovering that his country was bankrupt, run into the ground because of profligate politicians and an elite that was allergic to paying taxes.

Staring into an ocean of red ink that was one and a half times the size of the country's gross domestic product, the government in Athens was forced to seek out a 110 billion bailout from the European Union and the International Monetary Fund.

The price of that support was a wrenching austerity package that included sharp tax increases — and a promise to collect those revenues — privatization measures, and spending cuts. The result has been record unemployment that exceeds 16 percent (and is likely to increase) and a three-year recession.

Unfortunately, it has not lifted Greece out of its hole. As the release approaches of the next tranche of ?12 billion in aid that the country needs to pay back debt that matures later this summer, the EU and the IMF contemplate demanding a new five-year austerity plan. This new plan aims to raise ?50 billion through more privatization, and will cut public sector jobs by 20 percent — adding another 150,000 people to the jobless rolls over four years.

With a 155-seat majority in the 300-member Parliament, the prime minister should have been able to muscle the plan through the legislature when it votes later this month. But mass protests against the latest package has emboldened hardliners in the Socialist government who feel the mass privatization is a betrayal of their party's fundamental principles. (They also worry that it undercuts the unions that provide the backbone of party electoral support.) Three politicians have resigned in protest (but have been replaced by party members; the razor-thin majority holds).

There were hopes that Mr. Papandreou might be able to forge a national unity government, but those talks collapsed last week. A Cabinet shuffle resulted in the replacement of Mr. George Papaconstantinou, the finance minister who is the architect of the reform proposals, by Mr. Evangelos Venizelos, defense minister and powerful party insider; Mr. Papaconstantinou was moved to the environment portfolio. A vote of confidence for Mr. Papandreou was held Tuesday and he survived with a 155 to 143 vote with two abstentions.

Greece is likely to get the bailout package, no matter what happens domestically. There are mounting fears that failure to support Athens would trigger a default, which would spread throughout the eurozone. The cost of issuing Greek bonds has been rising as the market factors in the risk of default. Ominously, the cost of issuing Spanish bonds is reaching new heights, and the same costs for Irish, Portuguese and Italian bonds are also moving upward as markets in those countries tumble.

Those governments are not the only entities feeling the pain, however. The biggest holders of European government bonds are private banks in France and Germany.

Indeed, it is their exposure that has stiffened the spines of the governments in Paris and Berlin to demand full repayment rather than restructuring of the debt. Restructuring would take a toll on those institutions. To prove the point, the credit rating agency Moody's announced last week that it was reviewing three major French banks for a possible downgrade and warned that other banks are likely to come under scrutiny.

Ironically, the prospect of contagion is an indication of the success of the eurozone. The regional economies are so intertwined that serious trouble in one country cannot be isolated. (Some conspiracy theorists even suggest that the European Central Bank is taking a hard line against restructuring to force still tighter integration among the euro economies.)

A more likely explanation is that European hardliners, Germany and the Netherlands in particular, are not willing to finance irresponsible behavior on the back of their own financial discipline. The Berlin government continues to demand complete agreement on all elements of the new Greek plan before it agrees to a new refinancing package although its position softened late last week.

Rather than forcing banks to extend their holdings of Greek debt, those banks will be encouraged to roll over bonds as they mature. This "voluntary" formula is based on a deal struck with banks holding Eastern European debt in 2009.

A new package will likely be approved since the potential consequences of a default could be catastrophic. Restructuring looks increasingly likely and makes a certain sense. As it stands, governments will pay either by aiding debtor governments directly or by propping up their own overextended banks.

In addition, euro governments will have to increase the size of the current bailout fund; there are calls to double it to 1.5 trillion. The most important thing is signaling to the market that there will be no failures, nor collapses. It is a confidence game more than anything else at this point. Sadly, confidence is in short supply.



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