Greek bailout a done deal

EU finance ministers have signed off on a bailout for Greece totaling $170 billion (130 billion euros).

Wall Street Journal:

Euro-zone finance ministers early Tuesday agreed to an ambitious €130 billion ($172.1 billion) rescue deal that will see Greece's private creditors take an even larger loss in order to put the debt-laden country on a sustainable footing and avert a catastrophic default.

The agreement revolves around a debt exchange that calls for private investors to waive 53.5% of their principal under a massive debt swap that will cut Greece's outstanding debt stock by €107 billion. That goes beyond a 50% haircut agreed upon at a summit in October.

Speaking after the conclusion of more than 12 hours of negotiations, Eurogroup chairman Jean-Claude Juncker said the agreement "provides a comprehensive blueprint for putting the public finances and the economy of Greece back on a sustainable footing, and hence for safeguarding financial stability in the euro zone."

The deeper private sector haircut will help bring Greece's debt as a proportion of gross domestic product to 120.5% by 2020 from over 164% currently.

That appears to satisfy the demands of the International Monetary Fund, which had insisted that the final targeted debt ratio be as close to 120% as possible in order to participate in the bailout.

The board of the IMF will decide on the size of its contribution to the enhanced bailout deal for Greece "in the second week of March," IMF managing director Christine Lagarde said Tuesday.

Felix Salmon has identified the two major obstacles that make this plan a non-starter:

The plan assumes that 95% of bondholders will accept this deal, which seems optimistic to me. Bondholders are by their nature a fractious and contrarian bunch, and Greece is not saying that it's going to default on holdouts. As a result, bondholders have to guess what might happen if they fail to tender into the exchange: they might get defaulted on and receive nothing; they might get paid out in full; or they might get defaulted on while being offered, for the second time, the same exchange they're being offered right now. Some of them, especially the ones holding English-law bonds, might well be tempted to hold on to at least some of their bonds, just to see what happens.

More to the point, the plan assumes that Greece's politicians will stick to what they've agreed, and start selling off huge chunks of their country's patrimony while at the same time imposing enormous budget cuts. Needless to say, there is no indication that Greece's politicians are willing or able to do this, nor that Greece's population will put up with such a thing. It could easily all fall apart within months; the chances of it gliding to success and a 120% debt-to-GDP ratio in 2020 have got to be de minimis.

Europe's politicians know this, of course. But at the very least they're buying time: this deal might well delay catastrophic capital flight from Greece, and give the Europeans more time to work out how to shore up Portugal if and when that happens. Will they make good use of the time that they're buying? I hope so. Because once the Greek domino falls, it's going to take a huge amount of money, statesmanship, and luck to prevent further dominoes from toppling.

Salmon also explains the fantasy assumptions underlying the deal; that the Greek economy will begin to grow in 2013, for one. He also shows how rather than bringing Greek debt down to 120% of GDP by 2020, it is more likely that percentage will be 159%.

Currently, the debt to GDP percentage is about 160%.

I think the bondholders will balk and the Greek voters will throw out the entire government in elections next month. The new government, however long it might take to form, may be elected on a promise of not going through with the harsh austerity measures dictated by the EU. Or perhaps more likely, politicians will balk at passing the necessary enabling legislation for the austerity program to take effect. This will cause that government to fall and a cycle will begin that will destablize what is left of Greek democracy.

A probable future: Greece will default, exit the euro, and begin a slow, painful process of recovery. The efforts of the EU and IMF will now be toward containing the Greek collapse so that it doesn't begin a dominoe effect that will cause Portugal, Ireland, and perhaps Spain to follow in Greece's wake. Technically, the EU has the mechanisms in place to do that - a trillion euros (on paper) that can be used to buck up banks and flood the bond markets with ECB backed paper that might stem any run that starts on european banks with heavy exposure to Greek debt.

But much of this is theory and wishful thinking. The European Financial Stability Facility (EFSF) doesn't have near the funding it's supposed to and Germany is still blocking the European Central Bank from buying bonds from troubled economies. Other measures designed to control the Greek contagion that are contained in the bailout - including some fancy financial footwork on new Greek bonds - may bring Greece to a softer landing following a technical default which in theory, will not trigger the dominoes.

But as Salmon shows, there are just too many rosey assumptions, too much depends on Greece literally giving up its economic sovereignty for the bailout to be anything but another can kicking exercise to buy time for the EU to wrestle with the debt problems on their southern flank.

For that, the Greek people will suffer and Greece itself will go through a time of testing not seen since the unrest following World War II.