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Feb 22 2012

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EU Puts Greece in “Chapter 11”

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End Game in Play

European Ministers, world governments and financial markets are now deeply entrenched in a policy of “don’t ask, don’t tell” with regard to Greece, the implications of which are tangible and worrisome.

Yesterday, European leaders approved a second bailout for Greece – $172 billion in total – in return for truly draconian austerity measures to be undertaken by the Greek government proper. The overall agreement, which includes a component dealing with private sector creditors, aims to reduce Greece’s longer term debt-to-GDP ratio to a more manageable level by 2020.

The package announced yesterday, indeed all EU effort since 2009, was specifically designed to avoid a Greek default. But in fact, the concerted EU action yesterday was little more than putting “lipstick on a pig” of default.

Greece is bankrupt and effectively in default.  Without massive foreign assistance, Greece would have not been able to make a mandatory debt payment of $19 billion to its creditors on March 20th.

That’s just a fact.

What the EU leaders have devised in response is nothing more than a version of US Chapter 11 at a sovereign level, dressed up as something else.

Consider first the $172 billion bailout.

These are not loans to the Greek government that the Greeks in turn will use to manage their national affairs. In fact, after all the austerity so far – and the colossal austerity yet to come – average Greeks will see no relief from a single Euro.

Instead, the money is going into escrow accounts to pay foreign creditors of Greece, with the funds specifically shielded from the Greek government’s other financial needs, not unlike a trustee of a bankruptcy court.

In addition, the EU will send officials to Athens permanently to serve as inspectors to insure that Greece implements the austerity measures that it has agreed to.  Again, not unlike a trustee monitoring a person or company in Chapter 11.

And if further proof were necessary of the true state of Greek affairs, consider the deal with private creditors.

According to details released yesterday, Greece’s private creditors will “voluntarily” write off $141 billion of Greek debt, or about 70% of outstanding private Greek debt.  The “voluntary” nature of the write down is crucial, since the correct descriptor, “default” would trigger potentially uncontainable financial consequences in the EU.

But the voluntary nature of the write downs is a farce.  One of the priorities on the Greek legislative agenda going forward is a provision that would allow the Greek government to force bondholders to take the 70% write down if they won’t accept it voluntarily.

How can anything that is “voluntary” be compelled?

It is preposterous.

But for all this pretzel-twisting by EU authorities, what has Europe actually accomplished with the latest bailout?

The reality is probably very little at all.

According to an internal study by the EU-ECB-IMF, if all the Greek reforms and austerity are implemented and perform as advertised, Greek debt-to-GDP will still be at a precarious 129% in 2020.

However, small variations in expected outcomes could fundamentally change the trajectory of the figure and raise the debt-to-GDP level to 160%; which, after a decade of austerity, would still leave Greece without sufficient financial resources to cover its borrowing.

And current history has shown that relying on optimal economic performance in Greece is illusional. The country is in its 5th year of recession, with the economy contracting 7% year over year in the fourth quarter. Since last May, the size of the second bailout has risen as Greek economic performance has cratered.

In the final analysis, the coming failure of the EU bailout effort is apparent in the unvirtuous cycle where the very austerity required by the EU in return for the loans diminishes the ability of the Greeks to meet economic performance thresholds that are a requirement of the EU financing.

Further, nothing in the bailout package does anything to help the Greeks in the hear and now, nor does it provide any help to catalyze dynamic economic growth – the only tool left to the Greeks that can serve as a salvation.

It appears, based on these facts,  that after eighteen months of denial and half measures, European leaders have concluded that Greece cannot be saved.  However, the potential impact of a Greek default on Europe at this point, with its perilously weak southern economies, is too great a danger. So instead, the EU has engineered a strategic withdrawal to a more defensible line.

European loans  pay Greek creditors. Private creditors take the pain of “voluntary” haircuts now and get breathing room to recapitalize with generous and nearly cost-free ECB loans.  At the same time, EU supervision of Greek policies presents the best defense for keeping repayments on track.

The EU is both separating itself from Greece and trying to build a firewall around it; keeping the country afloat for as long as possible, so that the ripple effect of the event that is finally called a “default” can be managed in Brussels, Paris and Berlin.

Even after all their exertions, the effort may be short lived. While the EU has demanded that the major political parties in Greece sign on to the austerity measures, Greece is a democracy. When the reality of the bailout becomes apparent, how long will it be before a new political coalition in opposition to the terms of the bailout presents itself to Greek voters?

In any event, as a policy of self-preservation for the EU, this tactical move by EU ministers may buy time, despite the economic horrors that will be visited upon the Greeks as a result.

But, in fact, it is only a matter of time before the Greek economic horrors are visited on other countries in Europe unless there is a common and dedicated focus on the only real escape from the sovereign debt crisis – economic growth.

That is not apparent.

So, despite the rising Euro and Dow, prepare for a rocky road ahead.

 

 

 

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