Europe Watch: Junking Greece May Be Beginning of End for Euro

Jakarta Globe, Mark Gilbert, April 29, 2010

Greece cheated its way into the single-currency club, lied about its deficit for years, and now brings the shame of becoming the first junk-rated member after losing investment-grade status at Standard & Poor’s this week.

Greece’s punishment? A 30 billion euro ($40 billion) handout from its neighbors, with Germany on the hook for almost 8.4 billion euros, followed by France for 6.3 billion euros and 5.5 billion euros from Italy. The rest of the gang are expected to contribute pro rata, based on their capital subscriptions to the European Central Bank.

Portugal, for example, is in line to lend Greece about 774 million euros repayable in 2013 at 5 percent, even though the bond market was charging the Lisbon government more than 5.6 percent for its own three-year money this week. The bailout — misguided, misconceived and muddleheaded — makes less and less sense as the region’s crisis of confidence worsens.

This chapter didn’t feature when the euro script was written more than a decade ago. So it’s time for investors to start thinking about how the movie might end. The common currency may start to unravel in exactly the way its critics over the years predicted, as the folly of binding disparate economies to a single monetary policy without an accompanying fiscal alignment becomes clear.

“Debt restructuring in euro area member states is not an option,” European Union spokesman Amadeu Altafaj said.

Tell that to the bond traders pricing two-year Greek notes at 76 percent of face value, suggesting they are discounting a loss of 24 percent on their investment as the rescue plan fails and the Athens government reneges on its obligations. Or to S&P, which followed this week’s rating cut with a warning that investors may recover as little as 30 percent of their money in the event that Greece can’t meet its payment schedules.

S&P also slapped downgrades on Portugal and Spain, providing further evidence that the sovereign-debt crisis isn’t contained and that investors have every reason to be concerned about contagion.

The problem with the rescue package as currently designed is that it ends a day early and is a euro short. Greece needs more than 30 billion euros from Europe and 15 billion euros from the International Monetary Fund, and it needs more than one year of funding. IMF managing director Dominique Strauss-Kahn told German lawmakers that Greece may need as much as 120 billion euros.

The best solution would be to let Greece go bust. Extending the rescue net for longer, and throwing even more cash at the country, is almost a guarantee that the bond vigilantes will turn on Portugal, then Spain, and so on. And, now that it’s clear that Greece should never have been allowed through the door in the first place, the bouncers should grab the nation by the scruff of its indebted neck and toss it out.

Politically, the EU seems unwilling to contemplate such an amputation. So the gangrene will spread.

You know what’s coming next. ECB President Jean-Claude Trichet will recall his comments this month to the Kellogg School of Management in Illinois, when he said “crisis management requires agility and innovation to meet the idiosyncrasies of a specific crisis.” He’ll twist the rulebook to come up with some way for the central bank to start buying government bonds in the market, capping the yield increases seen this week in an effort to halt the contagion.

And he’ll bring forward planned rule changes on the collateral requirements to ensure that Greek banks can continue to exchange their government debt at the ECB for cash, even though it’s now junk at one rating company, headed for downgrades at the others, and trading well below its face value all along the maturity spectrum.

Twinning the debt crisis engulfing Athens with the largest bankruptcy in US history is increasingly popular. A Google search combining “Greece” and “Lehman” takes about 0.23 seconds to generate 933,000 references.

The analogy, however appealing, is mistaken. The US authorities let Lehman Brothers go bust in the mistaken belief that the finance industry had ample warning to prepare for the consequences of allowing economic Darwinism to finally take its course. The guardians of the euro, by contrast, are reading from an older playbook, the one that suggested it was a good idea to bail out Bear Stearns.

And we know how well that turned out.

Mark Gilbert, author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable,” is a Bloomberg columnist.

Investors across the world look to credit ratings agencies to judge where to place their bets in the market. (CNN)

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