Tuesday, February 21, 2012

Bailout Uncertainties

Greek debt pact is far from a done deal


By John W. Schoen

In their jubilant celebration over the latest agreement to solve Greece's debt debacle, European officials forgot to check with two important groups: the Greek voters and the bondholders who lent Athens the money it now says it can’t pay back.

The agreement once again buys the eurozone some time. Greek officials agreed to deeper spending cuts of 325 billion euros ($430 billion) and stricter budget oversight by the European Union. They also agreed to ask investors to accept less than 50 cents on the dollar on Greek bonds they hold. If all goes well, Athens will once again dodge bankruptcy with the infusion of the latest, $172 billion (€130 billion) installment in the ongoing bailout of the rapidly contracting Greek economy.

But the ink was barely dry before the top official of the International Monetary Fund, which has to sign off on the payment, gently reminded the parties that two important conditions still need to be met.

“As soon as the prior actions agreed with the Greek authorities are implemented and adequate financial contribution from the private sector (bondholders) is secured, I intend to make a recommendation to our Executive Board regarding IMF financing to support a program,” Christine Lagarde, Managing Director said in a statement.

The first condition -- making those $430 billion in budget cuts stick -- is a tall order. For the past four years, the Greek economy has been in a tailspin, shrinking by 20 percent as repeated rounds of government spending cuts imposed by European officials have stifled economic growth, further shrinking the country's tax base and fueling a vicious downward spiral. The Greek unemployment rate has more than doubled during that time; today, roughly half of Greeks aged 15- to 24-years-old are out of work. Each round of spending cuts has only intensified the economic pain on Greek citizens.

Greek voters will get a chance to weigh in on the deal in April, when parliamentary elections are scheduled. Candidates running on an “austerity” platform can expect an uphill battle in a country mired in a deep depression. Earlier this month, riots flared in Athens and other Greek cities as thousands joined protest rallies, burning dozens of buildings and looting businesses. On Sunday, thousands of demonstrators in Athens staged a repeat anti-austerity protest.

The architects of Tuesday’ bailout deal are hoping that Greek voters believe continued membership in the European Union is worth the pain of the austerity measures being imposed as a condition for remaining part of the economic club. The expectation is that leaders of the two main parties, the center-left Panhellenic Socialist Movement (PASOK) and the conservative New Democracy (ND), will win re-election and form a coalition that enforces spending cuts European officials are demanding.

“Certainly (the parties) will publicly voice their disgust with the program, but privately they will continue to go along with it,” said Douglas Borthwick, a currency trader at Faros Trading. But that scenario may prove overly optimistic. Support for the two main parties is at historic lows, providing an opening for smaller left-leaning parties opposed to the spending cuts, according to IHS Global Insight economist Diego Iscaro and country analyst Blanka Kolenikova.

“If the current polls prove true when the general election is held, neither the ND nor the PASOK would secure sufficient support to create a majority government,” they wrote in a note to clients Tuesday. “The winning party would be then forced to team up with smaller, radical parties, which would bring uncertainty and instability mid-term.”

Some observers doubt Europe’s demands are possible -- no matter who is elected.

“The package is based on unrealistic economic assumptions and will be no more successful than the first deal,” said Ben May, an economist at Capital Economics. “Accordingly, Greece or (European officials) may still decide to terminate the bail-out within months.”

The bailout bargain faces another hurdle well before the election, when Greece faces a March 20 deadline to come up with a 15 billion euro ($20 billion) bond payment it can’t make. To head off that default, Tuesday’s bailout bargain calls for Greece to tell bond holders they’ll have to “volunteer” to accept less than half of what they're owed. Though Greece has not yet technically defaulted, investors fearing they won’t get their money back have already bid down the value of more than 400 [billion ] euros of government debt outstanding. “For some reason, this is not officially being labeled a ‘default’ even though more than 100 billion euros of Greek debt are being written off by private bondholders,” said David Rosenberg chief economist at Gluskin Shiff.

The latest bond write down demanded by Tuesday’s deal would inflict even heavier losses than past proposals. Much of that “haircut” will be taken by European banks, who are now borrowing at record low rates from the European Central Bank. The hope is that those low rates will help them offset the hit they’ll take when Greece pays them back less than it originally promised. But those losses also will be inflicted on private investors, including hedge funds who have been gambling that the government won't come up with the money to pay them back. They've been betting against full payment with so-called “credit default swaps” -- a kind of insurance policy that pays off when a borrower defaults. That leaves them little incentive to agree to the deal.

If too many private bond holders refuse to take the haircut, those credit default swaps could be triggered -- with largely unknown consequences. In 2008, the cascading impact of credit default swaps sparked by the collapse of Lehman Brothers touched off a global financial panic.


“All the authorities have been able to do is delay default by a few weeks, perhaps a few months at best,“ hedge fund manager Dennis Gartman wrote in his investor newsletter. “Greece will default, but perhaps not under the present government in power.”




There is now a bailout agreement that has bought some time for the EU and for the Greek government, averting financial panic for the moment, but there is little confidence that it will be a long-term solution. It is hard to believe that Greek voters, confronted with steadily increasing economic pain under EU austerity measures which will continue for many years, will not at some point rebel and once again turn to politicians offering temporary relief, at the expense of further mortgaging the nation's future. But the limit to which the future of Greece can be mortgaged is fast approaching.

The only real uncertainty appears to be when and how Greece will default and leave the Euro system to return to the drachma. It is still possible for Greece to avert that dire extremity, restructure its economic policies and continue membership in the European Union. In the long run that would lead to a far better future for Greeks, however the short-term political consequences are so formidable that most knowledgeable observers do not expect this to happen.



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