Will the Greek Bailout Work?

File:Parthenon-2008 1

For now, financial markets seem cheered by the news that European leaders have put together a rescue program for Greece. But Wolfgang Munchau argues that it ultimately won’t be enough to avoid a default event:

So will this stave off insolvency? It is important to distinguish the near-term insolvency as a result of the failure to roll over existing debt, and the country’s long-term solvency position. This deal, I am confident, will solve the first issue. As I predicted last week, Greece will not default this year. But I am still sticking with my second prediction that Greece will eventually default. The numbers simply look too bad. The adjustment effort Greece is asked to make will be one of the largest in history. But unlike other countries that made a similar effort in the past, Greece cannot devalue; it faces a much more challenging global environment; it has a weak fiscal infrastructure; a low consensus in society in favour of deep reforms; and a fragile financial system. The agreed bail-out terms do not exactly offer much relief, except in the very short-term. It will become clear very soon that this loan agreement represents a net transfer of wealth from Athens to Berlin – and not the other way round.

His point is not that owners of Greek bonds will be totally wiped out, but that some form of restructuring that constitutes a “default event” will be necessary unless Germany and others are prepared to put something together that offers much more relief.

Meanwhile, it’s been interesting to observe the disparate reactions of financial markets and politicians to the Greek saga. There’s a kind of popular prejudice in economic commentary circles that political factors tend to drive democracies toward looser-than-optimal policies. But throughout the Greek debt crisis, financial markets have generally been cheered by all signs of Franco-German generosity and impulses toward generosity have consistently been curtailed by public opinion and other political factors. And you’ve seen a similar dynamic in the United States. Things like TARP and other “bailouts” have quite clearly boosted equity markets, cut interest rate spreads, and otherwise tended to do exactly what you want stabilization to do but they’re toxically unpopular and consequently political leaders haven’t done as much of them as would be ideal.

You can gloss the conventional wisdom as saying that the public favors short-term gains over long-term considerations. The truth, however, appears to be that in a crisis the public is more interested in considerations of fairness (Greece, Goldman Sachs, whomever doesn’t deserve one red cent!) than in considerations of growth. There’s considerable popular desire to engage in basically spite-motivated policies—let all of Europe sink, as long as Germany sinks slower than the rest.