This Week in Europe

Okay, so a lot of things have happened since I last checked in with the situation in Greece. Where do we start? The upsized EU-IMF bailout is a good place. For those who have been under a rock for the last week, Sunday the EU and the IMF issued a statement detailing a 110 billion euro package of loans (at around 5% interest) for Greece, effectively removing them from private funding markets for the next two and a half years. The loan schedule was contingent on Greece implementing a strict set of austerity measures. Also included in the plan were much more realistic economic forecasts, in which the debt to GDP ratio peaks at 149% in 2013, falling from that point. Other bloggers/sites have told the story of last week better than I could here, so I will only comment on the broader issues behind this package.

It strikes me that the package announced by the EU/IMF will only serve to stave off a default by Greece (which would occur when their next bond matures on May 19th without the package). Why is default still inevitable? To answer this question, we must revisit our math on sustainable soveriegn debt loads. Assuming that Greece achieves trend growth of 2%, and that their average cost of debt is 5% (resulting in interest payments of 7.5% of GDP), it would be necessary for Greece to achieve a primary surplus of 5.5% in order to stabilize the debt/GDP ratio. Greece has never achieved this. So why lend them money at all? Well it appears to me that the idea was to prevent contagion until the other peripherals (who’s debt/deficit statistics aren’t as ugly as those of Greece) got their collective acts together and stabilized their fiscal situations – essentially to buy time for the other peripherals. I hope nobody at the EU-IMF summit was kidding themselves about Greece’s ability to achieve the fiscal consolidation necessary to avoid a debt spiral. The calculus appears to have been that the loss which will results from the restructuring of Greek sovereign debt (more on this later) will be outweighed by the ‘cost savings’ of preventing similar crises in Spain, Italy, Ireland and Portugal. This struck me as a relatively reasonable approach to mitigating the impacts of the crisis, despite the enormous agency problems it introduced for the peripherals. Too bad the Greeks ruined it all by rioting and shaking the market’s confidence in Greece’s ability to implement the austerity program and thereby putting enormous market pressure back on the remaining peripherals, with the chaotic results we witnessed in markets this week.