Greece Does the Right Thing, after another Turbulent Week in the Euro Area

A deadline before a deadline before a deadline. The political brinkmanship in the euro area crisis has clearly reached new levels in recent weeks, culminating in the vote in Greece’s Parliament on June 29 to accept a tough austerity package in return for new loans to avert a default. The vote demonstrated that for all the turmoil of this spring and summer, there has been considerable movement toward at least a temporary solution for the Greek debt crisis.

Perhaps understandably, financial markets have not always known what to make of these games of chicken. First the International Monetary Fund (IMF) told the euro area to commit to fully fund Greece for at least the next 12 months, before the IMF would participate in the next program disbursement in July. Then the euro area turned around and demanded that Greece agree to new austerity measures, and insists that Europe’s banks "voluntarily" roll over a substantial part of their maturing Greek bonds, before the euro area will commit any more money .

Despite the demonstrations in the streets of Athens, it has been clear for some time that Prime Minister George Papandreou’s reshuffling of his government earlier this month would help secure a narrow parliamentary majority for the new austerity and privatization measures. Even the threatened rebellion of some Panhellenic Socialist Movement (PASOK) backbenchers did not preclude adoption by a parliamentary majority. In any case, in the final parliamentary vote, only one member of Papandreou’s Socialist party voted against the law and the speaker of parliament announced he had been immediately expelled from the party. One deputy from the conservative opposition cast a vote in favor. The key message here is that both parties split on this vote, suggesting that despite all the political rhetoric in Greece between the two main parties, a bipartisan majority of the Greek parliament would not vote to push Greece into a messy default.

The vote also resulted from the uncompromising public stance of other European countries, which directed appeals of "Greece needs national unity" and "there is no plan B¹" toward the Greek political elite. Not only were all the Greek parties (including PASOK) split over the issue, including the followers of Antonis Samaras, leader of the main conservative opposition party. It was always likely that if Papandreou came up a few votes short, he could find alternatives delivered by "dissident" opposition MPs².

In the end, a majority of Greek MPs rose to the historic task and avoided sending Greece into a disorderly default and economic collapse. Here the longer-term political issue is not whether the new austerity and privatization measures will be implemented to the letter. Indeed, privatization measures might especially fall short of targets before 2015. The broader political significance, however, lies in the message sent by the Greek government’s unflinching willingness to ignore large-scale public protests and instead push forward with the agreed set of measures. This fortitude in the face of angry demonstrators has been just what was needed for euro area leaders (and not just in Germany) to stand by Greek leaders. Ultimately Greece’s "satisfactory standing³" with the IMF program conditionality will be critical in future European flexibility when a likely debt restructuring end-game negotiation begins, perhaps by 2013.

As predicted earlier in this blog after German Finance Minister Wolfgang Schauble floated the idea of a "soft" Greek bond restructuring, and the European Central Bank (ECB) forcefully rejected the idea, European leaders have settled on a strategy of "voluntary" rollovers of debt.   As they have put it, the goal is to bring about a "voluntary private sector involvement in the form of informal and voluntary roll-overs of existing Greek debt at maturity for a substantial reduction of the required year-by-year funding within the program, while avoiding a selective default for Greece." Agreement on this will need to be reached by the extra eurogroup meeting on July 3. The negotiations between euro area governments and private European banks and other financial institutions are consequently encouraging.

It’s too early to judge what the final format for private sector participation will be. The discussions are still mostly occurring on a national basis, with French officials talking to French banks, German officials to German banks and so on. However, the fact that coherent (if predictably self-serving) proposals are now being put forward by private banks suggests that substantial shifts in positions have occurred in recent weeks. The status quo in the euro area peripheral debt crisis—in which Greece, Ireland and Portugal received 100 percent taxpayer funded bailouts —has seemingly been undone. Greece’s second bailout will not be similarly 100 percent taxpayer funded. Despite all the talk about Germany’s backing down in its fight with the ECB over this issue, the fact that private banks now seemingly accept that they must foot part of the bill represents a major change in "euro area bailouts conditions." And that change has been toward Germany’s position. Chancellor Angela Merkel has some reason to be pleased.

Finally, the delicate negotiations between European governments and private financial institutions about the scope and format of the institutions’ participation makes it all the more inconceivable that the ECB would "push the nuclear button" and reject Greek collateral. The central bank’s likely refusal to do so would not even be affected by credit-rating agencies declaring that the rollover constituted a "credit event" necessitating a downgrade of Greek debt after July 3. A flexible ECB stance entailing perhaps a two-tier liquidity provision system, where "healthy banks" continue to use the regular repo operations and "problem banks" in Greece and elsewhere hold "defaulted collateral" in a new "special conditional facility" seems a likelier outcome. Credit rating agencies will thus not be given veto power over a deal to avoid economic chaos in Europe.

Notes

1. http://globalpublicsquare.blogs.cnn.com/2011/06/28/and-if-the-greek-bailout-fails/. Note, however, that while publicly there is no plan B, "contingency planning" is certainly taking place behind closed doors in order to be able to deal with the fallout from a possible rejection by parliament. See http://www.euractiv.com/en/euro-finance/eu-officials-mull-plan-greece-news-506008.

2. The principal political loser from the unwillingness of Antonis Samaras to offer support for new Greek austerity measures, despite repeated calls to do so from other European leaders, seems to be the center-right European People’s Party (EPP) grouping in Europe, to which Samaras belongs. The EPP has now shown itself to—when it matters—be a useless and toothless grouping with no sway over or willingness to sanction even the most recalcitrant of its members. Certainly, Samaras’ behavior and the (lack of) EPP response have in the last couple of weeks underlined the meaninglessness of the concept of "Pan-European" political parties.

3. "Satisfactory standing" in political terms does not mean that every piece of the IMF program must be 100% implemented, but instead that the Greek government must try its utmost to implement the majority of the IMF program and be seen to lay the ground work for a lasting economic transition of Greece.

4. See for instance the French Banking Federation’s Proposal [doc].