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The real Greek tragedy

Greece will default. The question now is how well the fall will be handled. Pramit Pal Chaudhuri writes.

india Updated: Sep 28, 2011 23:12 IST
Pramit Pal Chaudhuri

The Greek government will default, the question is only when and how. The last is especially important. A managed default will merely mess up the books of a few French banks. An over-the-cliff event could mess up the world economy for the second time in three years.

German Chancellor Angela Merkel and French President Nicholas Sarkozy are putting up a brave front, insisting default is not an option. The market thinks differently.

After speaking with a cross-section of bankers, investors, analysts and diplomats in the West the past two weeks, the unanimity with which all say default is inevitable is striking.

Even Germany is signalling that it accepts Greeks will have to deep-six its own government bonds. In the present battle over expanding the Bailout of Last Resort, the European Financial Stability Facility (EFSF), Berlin is pushing for the incorporation of a managed default of Greek government debt to the tune of ¤50 billion.

France, whose banks are believed to hold a lot of Greek debt, is resisting.

But Europe is running out of other solutions to Greece. As Ed Yardeni of analytical firm Yardeni Associates has noted, Europe is now on Plan C. One, Greece can’t be expelled from the eurozone, there isn’t enough time.

“It’d take at least five years to work out the process,” says one Europe analyst for a New York consultancy. One US diplomat, noting that the European Union has no codified means to expel a member, said it was possible Greece could veto its own eviction.

Two, bailouts are merely deferring an inevitable Greek default. Consider the latest bailout of ¤109 billion. Because Berlin is demanding private sector involvement — in other words, private banks must share the red ink when it all comes tumbling down — only half the bailout will actually go to Greece.

The other half is going to guarantees against the default of the other half. So the aid component is diminishing even as a shrinking Greek economy means bailout requirements — and the guarantees for such bailouts — are growing faster than aid is coming in.

And that doesn’t even include the rising reluctance of north European taxpayers to see their savings go into shoring up Greek bonds, which the market treats like less-than-junk — three-year Greek bonds offer a staggering 172% return.

The issue is more than just Greece. The German concern is that the default shock won’t stop only with Greece but also bring down Portugal, Spain and perhaps even Italy. Hence the need to expand the EFSF to as much ¤1.5 trillion to buffer a Greek bust-up.

The French concern is that their banks — Societe General would have to be nationalised if Greece went under, say Wall Street bankers — will have to absorb a lot of that ¤150 billion loss. Speculators are already circling in expectation.

The rest of the world is financially dista-ncing itself from Europe. The debate in the US is almost solely on how to survive the expected financial tsunami. A US Federal Reserve Bank senior vice-pre-sident was optimistic that the US economy would be stirred but not shaken by a Greek blowout.

“We have set up regulatory buffers post-Lehman. US banks have been preparing themselves for months.” American banks have dumped European sovereign debt and stopped lending to banks across the Atlantic. Even the Bank of China, after much talk of saving Europe, has stopped trading swaps and options with Europe.

The good news is that Europe is moving to the inevitability of a Greek default, however disguised. The manoeuvring is now largely about who will have to absorb the losses — German taxpayers, French banks or suckers who bought Greek bonds.

The bad news is that no one is quite sure how it will affect the rest of the world. Who would have guessed that just the run-up would result in the rupee falling to a near two-year low against the dollar?

Warns Tim Adams of the Lindsey Group, an economic consultancy, “Europe will do what it takes to manage through the crisis but there are many ways in which is comes off the tracks.”

A State Department official had some worst-case musings: “Greece can said to have started western civilisation. Greece might just bring it to an end as well.”