Friday, July 22, 2011

Thoughts on the latest and greatest Greek bailout

I'm still trying to digest the reported bailout of Greece.  On the surface it seems like a very strong plan, with Greece being bailed out and the European Financial Stability Facility (EFSF) being authorized to buy bonds in the secondary market in order to help keep yields from going crazy.  In some ways, it's the European version of our own TARP plan.  The European markets seem to especially like it.  However, as always, I've found the devil is in the details and there are a few that are making me a bit skeptical:

  1. This is the third "solution" to the Greek crisis that European leaders have announced in the last 14 months (previous ones were in May and September 2010).  European leaders seem to like to do just enough to calm investors for a few months, but not actually do anything to solve the problem. 
  2. Even with the reported 21% haircut on Greek debt, which puts Greece in default, Greece still has a debt-to-GDP ratio of 130%, which is still an unsustainable debt level for a country like Greece.  It would be one thing if Greece had a balanced budget as the terms of the EFSF gives Greece debt at extremely attractive terms (Supposedly minimum 15 year terms at 3.5-4.5%).  But the Greek economy is in shambles and will only get worse following their austerity plan, which could cause tax revenues to miss targets.    If tax revenues miss targets, it's possible that the current austerity plan won't be enough to satisfy the IMF and the EU (especially the Germans).  Remember, they previously passed an austerity plan last year, which worked so poorly that the IMF was holding up a tranche from their original bailout, requiring them to pass another austerity plan.
  3. The EFSF was just empowered to do a lot more than it has been doing but there was no mention of more funds going into the EFSF.  Given the size of the markets we are dealing with, this could create a major problem.  My guess is that any increase in the EFSF would need parliamentary approval from the member states that contribute to it and that is definitely not a certainty.  Governments might be brought down by such a vote and the EU politicians know it.
  4. It's been made clear that Greece is getting a unique deal and that governments in Ireland, Spain, Portugal and Italy can't expect the same.  My guess is that their first question is "why not?".  It's not like Greece is in this position through no fault of their own.  It's actually completely and utterly their fault (they even purposely lied about their level of debt on a regular basis, and may be still doing so), so from a moral and ethical standpoint it doesn't seem to make sense to put Greece in a special category.  Though the idea of private investor haircuts across Euroland is very scary.
  5. What happens to all the credit default swap (CDS) insurance on Greek debt?  With a 21% haircut, can't they be triggered?  What happens then?  US banks have about $34 billion in CDS exposure to Greece, does that mean US banks are on the hook for billions now?  The potential seems to exist for some sort of unintended consequence from the haircut causing massive problems somewhere (though we don't know for sure where). 
  6. Because the US is a major contributor to the IMF, we are probably on the hook for $15-20 billion on this bailout.  Won't this appropriation have to pass Congress?  I think an argument can be made for us not to approve that additional funding.  After all, we have to issue debt to pay this money (assuming the debt ceiling is raised) so does it make sense for us to mortgage our children's future for the sake of people thousands of miles away in another country who have been living well beyond their means for years (and retiring 5-10 years ahead of the average American)?  Also, wasn't the Euro created, at least partially, to challenge US Dollar hegemony.  So why are we bailing them out?  I can definitely see us balking at this.    
Anyway, those are my key concerns with this whole bailout.  We'll see how long this keeps things calm.  Some people are already predicting trouble coming in the fourth quarter of this year, so after all that work, they might have only bought themselves a few months.  There really are only two permanent solutions to this problem, in my opinion.  The first one is that there will be a Euro fiscal union so that everyone has the same fiscal policies.  I don't think this is really workable as the Greeks don't want to be told what to do by the Germans and vice versa.  The second one is you just allow countries who want to, to leave the Euro.  I've mentioned before that I think it's in Greece's self interest to go back to the Drachma and I still think so.  I think their pain would be of a much shorter duration if they did that.

Let's see how long the band-aid stays on this time.

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