From the beginning of the European debt crisis, eurozone leaders have been one step behind. That's why this crisis has lasted so long and grown so wide and deep.
And it's now clear, on the eve of yet another emergency summit meeting on Wednesday, that the currency union's political and financial leaders are about to do it again. Whatever cobbled-together solution they announce as their grand plan that day will, once again, be a step behind the evolution of the crisis.
And this time the lag will be especially big and potentially devastating to hopes of ending this crisis. Recent news makes it clear that the crisis has now become primarily a political one. But eurozone leaders continue to treat it as a crisis that can be solved with technical financial fixes, such as insurance schemes to leverage the European Financial Stability Facility.
The lag in addressing the euro crisis as a political crisis means that when -- notice I'm not saying "if" -- Greece defaults, the damage to the European banking system will be greater than it need have been. In fact, the whole fabric of the great postwar edifice of the European Union will be in danger of collapse.
Sadly, we didn't have to get to this point.
A look inside the problem
What has happened in the past few days to convince me that the evolution of this crisis has left the proposed solutions so far behind?
Jim Jubak
Mainly, it was publication by the Financial Times on Saturday of a confidential report on the continued deterioration of the Greek economy from the International Monetary Fund, the European Central Bank and the European Union -- the so-called troika in charge of investigating Greek finances and deciding whether Greece had met the requirements for receiving the next $11 billion in bailout money.
It seems that under the dual impacts of the global economic slowdown and the austerity measures taken by the government to meet the terms of the troika's rescue package, the Greek economy has contracted more than predicted when the eurozone put together its rescue package in July. At that point, calculations were that if Greek bondholders wrote off 21% of the value of their debt and if the Greek government cut its budget and sold off national assets, it would take $150 billion in rescue funds to enable Greece to get to a point in 2014 or so where the country would be able to go to the financial markets to meet its financing needs.
The troika's new calculations show that it's now likely to take $350 billion and more time -- possibly until the end of the decade -- to reach that point. And if the Greek economy takes a turn for the worse -- if, for example, the zone as a whole falls into recession again -- the rescue bill could climb to $610 billion.
That $610 billon exceeds the theoretical $600 billion cap to the European Financial Stability Facility. (I say "theoretical" because some of the facility has already been committed and some of that $600 billion isn't actually available for rescue work because it's needed to back the facility's finances.)
Quite a problem, no?
Stretching the money
Right now it looks as if eurozone leaders are going to try to financially engineer a solution to the problem. The solution will include leverage to increase the firepower in the European Financial Stability Facility well beyond $600 billion and some increase in the haircuts that banks and other holders of Greek bonds will have to accept.
There's a trade-off, you see, between the size of any rescue fund and the size of any write-down in the amount that Greece has to pay its bondholders. For example, to get back to a rescue package roughly the size of the July package -- $157 billion instead of $150 billion -- and to avoid the need for a $350 billion rescue package, Greek bondholders would have to take a 50% write-down of the value of their bonds.
Considered just as financial engineering, that solution has a number of problems. I am troubled by two in particular.
First, the current estimate of the required rescue package at $350 billion isn't likely to hold. For example, with further austerity measures, the Greek economy is likely to shrink even more than is now forecast, cutting tax revenue and resulting in even bigger budget deficits. And it's reasonable to expect even more slippage of the sort that we've seen so far from the Greek government. A sale of assets originally forecast to bring in $91 billion now looks as if it will bring in just $63 billion, according to the troika. And cuts to the government workforce have been implemented more slowly than projected.
Second, for this bit of financial engineering to work, the engineers have to thread their solution through a very narrow strait. They've got to persuade banks to take a big hit to their balance sheets, and to do it voluntarily. A forced write-down, credit ratings companies such as Standard & Poor's have said, would be ruled a default by Greece. That would trigger, in all probability, the insurance features of credit default swaps. Bondholders who had bought these derivatives to insure against a default would be entitled to payoffs from the financial institutions that had sold these derivatives.
Bottom line, nobody is quite sure who is holding the bag here. The fear is that some important institution somewhere in Europe -- or elsewhere in the world -- would wind up with more claims against it than it can afford to pay. The result could be a replay of the American International Group (AIG, news) crisis in 2008, which almost brought down the global financial system.
Continued on the next page. Stocks mentioned: BNP Paribas (BNPQY, news), Société Générale (SCGLY, news), Crédit Agricole (CRARF, news) and Dexia (DXBGY, news).
