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Easy Street

Greece: When the bailout is worse than the sickness

Heidi Moore Feb 28, 2012

Well, that was fast.

Less than a week ago, European officials stayed up working past 3 a.m. to approve a Greek bailout payment that had bitterly divided the Continent for well over a year.

The 130 billion euro bailout payment was meant to prevent Greece from defaulting on its financial obligations, provide security to banks that the country would remain trustworthy, and keep Europe as a whole further away from the brink of financial disaster.

Currently, that plan is 0 for 3.

Last night, Standard & Poor’s declared that Greece is in “selective default.” My colleague Stephen Beard offered a clear explainer of what means: Greece is in fact unable to pay its debt – it is in default – but the default is orderly. No surprise there – just as with its downgrade of the U.S., S&P signaled months ago that the option was on the table. S&P said it’s a default because Greece’s bailout package  doesn’t give people who already own the country’s bonds any real option to reject new, cheaper Greek bonds.  Look back at my explainer of the new terms: if a bondholder owned $100 of Greek bonds, he will be forced to accept something like $26.60)

Although the S&P move isn’t a surprise, it is a temporary disaster for Greece because it sets off a chain of financial dominoes: Europe has already agreed to back all of Greece’s financial obligations with a European bailout fund. That plan is not yet in effect. Greece is already in default. Greek banks hold Greek bonds as security, and borrow against them – the same way U.S. banks hold U.S. Treasury bonds. There is no financial backing to that Greek debt now. The banks are left high and dry, unable to borrow against those bonds; they are less stable now than they were three days ago. The ECB can’t do anything about it.  The ECB asks national central banks – including the Greek central bank – to provide emergency funding to Greek banks. The Greek central bank is already strained and hardly rolling in dough. S&P wonders how long Greece can go without starting this circus all over again.

Reuters sums up the importance of the issue – to banks in Greece and elsewhere in Europe- nicely. Greek banks in particular can’t survive this phase without the support of central banks:

The issue is vital because Greek banks would almost certainly go bust if their central bank funding was withdrawn. Other banks in countries like France also own large chunks of Greek debt, though they have other assets to use as collateral.

So here we are, less than a week after the Greek bailout payment was approved, and the country’s banks are actually closer to going bust than they were before European officials stepped in with their cure.

To paraphrase the puppet Lamb Chop, this is the bailout that doesn’t end.

This situation is allegedly temporary, but what makes it remarkable is that it arises from sloppiness and thoughtlessness in planning. Had European leaders gotten a little more sleep instead of ostentatiously staying up until 3 a.m., they perhaps could have remembered S&P threat of declaring default and provided a way for Greek banks to survive the death of the old Greek bonds. They also might have prevented the European Central Bank itself from owning huge blocks of Greek bonds. So says Peter Tchir, at TF Market Advisors, suggests that Europe has mismanaged the Greek bailout to the point of catastrophe for all the other members of the Eurozone:

It just strikes me that Europe wasted a year or more, and has created a less stable system than it had before.  A year ago, Europe was adamant about no haircuts and no default.  I could never understand why.  Let Greece default, renegotiate terms, stay in the Euro and move on.  The key then, as now, was ensuring that banks that were solvent had enough liquidity.  Rather than take that advice, Europe proceeded to buy Greek debt, which not only failed miserably, but has complicated the situation.  The ECB holdings stick out like a sore thumb.  Had Greece been allowed (or forced) to default and restructure when the crisis first hit in 2010, the ECB wouldn’t own a single bond.

Part of the problem, as Slate’s Matthew Yglesias pointed out, is that, while Europe talks about keeping Greece in the Eurozone, “everyone’s first choice is for someone else to pay the freight.” And no one at all wants to read the fine print.

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