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Why Europe is delaying Greece's default

BERND KAMMERER/BERND KAMMERER/ASSOCIATED PRESS

Some things in life are simply inevitable: The NHL will abandon its failed experiment in the Arizona desert; Fed chairman Ben Bernanke won't tell us anything we don't already know at his historic first press conference; and Greece will restructure its debt.



As for the Greeks, the only question is why is something so obvious taking so long?



Greece, like Ireland and Portugal, is insolvent. If it was a corporation, the bankruptcy experts would have called in the secured creditors long ago to inform them that the only way to avoid liquidation was to accept extended terms on their loans and maybe 30 or 40 cents on the dollar at the end.

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Instead (not unlike the NHL in Phoenix), the Greek government and its lenders of last resort, the EU and IMF, have opted for a much slower and more agonizing process that is causing considerably more pain for the Greeks and unnecessary uncertainty in the markets. If the euro zone countries can't fix this mess in a timely manner, what good are their guarantees about the future of the monetary union?



The reason for prolonging Greece's agony has nothing to do with the needs of the Greeks or the bond market and everything to do with the fragile health of banks in Germany, France and a handful of other euro zone locales that happen to be stuck with vaults full of Greek, Portuguese, Irish and Spanish bonds.



"It's not an easy decision to make, because nobody knows exactly how it will play out," says Nicolas Véron, an expert on European banking at Bruegel, a Brussels-based think tank. "The Europeans (to their major shame) have not yet been able after more than two years to put Europe's major banks back on a sound footing, so everybody is afraid of the shock waves."



Mr. Véron notes that their preferred solution is to keep kicking the proverbial can down the road, which is no kind of solution and can't continue much longer.



On Tuesday, we learned that Greece's budget deficit last year reached 10.5 per cent of GDP, well above the 9.4 per cent the government was estimating just two months ago. Which tends to happen when your economy shrinks 4.5 per cent.



"I don't think that Greece will succeed in this consolidation strategy without any restructuring in the future, or perhaps also in the near future," Lars Feld, who sits on the German government's economic advisory council, declared in an interview on Bloomberg Television. "Greece should restructure sooner than later."



Greek politicians can criticize bond-rating agencies as much as they like. But the agencies are merely following the market with their downgrades and warnings -- not leading it. Putting off a restructuring won't do anything to rescue the economy from its current downward spiral, make borrowing costs cheaper or save their political hides.

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Taking the full hit now would be deeply painful, and not only for the Greeks. But it beats the alternative. And it might force the Europeans to deal with their severely damaged banks and finally tackle the fiscal and other structural problems that led to this mess in the first place.



The analytical minds at Goldman Sachs assure us that the hit to European bank balance sheets would not be as heavy as it would have been last year, thanks to loans from the European Central Bank, which has adamantly opposed a quick Greek restructuring. Their estimate of the effect of a haircut of 60 per cent: bank losses totalling €41-billion. A more modest 20 per cent cut would result in losses of €13-billion.



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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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