There are a few truisms that pop up again and again in my life; Everything takes longer and costs more; Nothing is simple and There are no simple answers to complex problems. All of these seem to be true of the Greek debt crisis. There are a couple of articles in the New York Times today that lay out the scope and complexity of the problem, you can find them here and here.
Unlike the United States the Greek government is actually in a debt crisis. They have probably entered a debt trap, where they don’t have enough money to pay all their normal bills plus the interest on their debt. This means that they have to borrow to cover the interest. Of course when they borrow they have more interest and more debt.
Unlike the United States or other nations who have a sovereign currency they can’t just devalue their currency or lower interest rates. Being part of the EU and the Euro zone these things are controlled by the European Central Bank.
This puts them in a really bad place with few options. Right now the three groups that are loaning them money, the IMF, the European Union and the European Central Bank are demanding cuts or savings totaling $40 billion by 2015. That is a huge amount of the Greek GDP, nearly 12% of GDP. To give you an idea of what that would be in the United States economy it would be like cutting out $1.75 trillion (yeah, 175,000 billion) in the same time period.
To do this the Papandreou government is basically going to have raise taxes, slash wages and employment and sell off a bunch of the state owned assets of the nominally Socialist state. The question that is starting to emerge is, will this actually fix the problem?
By hitting wages while raising taxes and cutting jobs. That is going to make the current Greek recession even worse, reducing the amount of money that these tactics will generate. Combine that with the fire sale on the State owned assets and you can easily understand why the Greek people are in the streets.
There have already been some, particularly a friend of mine who blogs under the name “fairleft”, who have been agitating for Greece to leave the Euro zone and regain the ability to have its own currency and basically tell its creditors to take a long walk off a short pier in the Aegean. This approach has some attraction, but there are problems with doing this as well.
You see the world is still full of derivatives (remember derivatives?). These are the type of insurance against bond default that got the US economy in such hot water. And yes there are people betting against the Greek debt ever being paid. The problem here is that no one knows (or if they know are not saying) exactly how much money is in this ticking time bomb. From the New York Times article:
The looming uncertainties are whether these contracts — which insure against possibilities like a Greek default — are concentrated in the hands of a few companies, and if these companies will be able to pay out billions of dollars to cover losses during a default. If there were a single company standing behind many of these contracts, that company would be akin to the American International Group of the euro crisis. The American insurer needed a $182 billion federal bailout during the financial crisis because it had insured the performance of mortgage bonds through derivatives and could not pay on all of them.
Even regulators seem unsure of whether a Greek default would reveal such concentrated risk in the hands of just a few companies. Spokeswomen for the central banks of both Europe and the United States would not say whether their researchers had studied holdings of such contracts among nonbank entities like insurance companies and hedge funds.
Not exactly the kind of thing that makes you sleep well at night, is it? Especially when the central bankers won’t say if they’ve looked at it or not. That lead me to one of two conclusions, either they have not done the work, which is bad enough, or they have done the work and know that there is another economic tsunami coming if Greece defaults and they don’t want to say.
The problem is that while there has been some move to bring derivatives out of the dark, the work is just starting and there is no provision for older contracts to be exposed. Right now it would be very hard to say with any accuracy what the exposure for banks with these contracts (bets) the estimates range from $5 billion to $78 billion.
If the latter figure is the more accurate one, and there is a concentration of those contracts in a single bank or, even worse, a country that is in its own debt problem in Europe, we could see a real domino affect as the contracts come due, if Greece actually defaults.
Like I said at the start, nothing is simple. We have to also keep in mind the pain of the Greek people. Unemployment there is currently running at 16%. That is before the next round of job and wage cuts. The austerity measures the EU is demanding from Greece are going to make that much worse, as they will deepen the recession that is already incredibly painful. It will lead to more unemployment and that will push the amount of tax revenue down.
I don’t know what the solution to all of this is. I wish I was that smart. It is possible that the EU will keep Greece in the Euro zone and make them destitute in order to keep a default swap time bomb from wrecking the rest of their continental economy. Then again Greece may decide it does not care about the rest of Europe that much and bail out of the Euro zone (there is not actually any provision in the treaties that created the Euro for a country to do that, but if they start printing their own money what can the EU really do?)
That would be a very scary thing for the rest of the EU, Ireland, Portugal and Spain are all in less dire versions of the problem that Greece finds itself. If the government in Athens bails on the Euro, it would surely tempt these countries to do the same. That would be a major economic disruption in and of itself.
In the end we are where we started. It is going to take longer than anyone thinks to fix this; it is going to cost more money than anyone wants. There will be no simple answers because the situation is complex.
The floor is yours.