The next few weeks will reveal whether the European Union will decide to put its money behind its words and in some sort or form bail out Greece.
Since Greece has not defaulted yet, it is unlikely that there will be a detailed plan laid out on the mechanics of said bailout. Most likely, the word out of Brussels will either be a guarantee on Greek government debt or a softer approach of extending a low-cost line of credit to European banks (including Greek ones) that have the most exposure to Greece.
Although I hear the ECB is not accepting Greek government bonds as collateral for sometime now, it is still allowing private Greek banks to borrow, banks which in turn buy Greek government bonds, effectively allowing Greece to keep accessing the European debt markets and any available ECB lifelines.
By the end of spring, Greece will have to rollover about €16.5 billion in sovereign debt (€8 billion redeems on April 20, €8 billion redeems on May 19 and €500 million on May 31st). The first 10-year auction is scheduled for late February (possibly the 22nd) according to the Greek Debt Management office. The bookrunner for the upcoming auctions is (who else?) Goldman Sachs, which gives me an added reason to believe the auctions will be successful, but in case they are not, then Brussels will need to decide on whether to provide a lifeline for Greece or not.
Some would argue that a possible Greek bailout goes contrary to all contract law and principles of market economics, induces moral hazard and penalizes the average EU citizen that lives within his or her means (with the Germans most likely to foot the majority of the bill). After all, for years the Greek governments doctored reported economic numbers, ran huge budget deficits and ignored the Treaty of Maastricht requirements as if they didn’t apply to them.
If this was purely about market economics, I would be the first one to argue that the EU should just let Greece fall. It would be the fair thing to do, after all, to a member state that has effectively cheated their European partners, and it would not be so bad for Greece in the long-run either. It would allow Greece to go back to an era of sovereign monetary policy with the ability of the country to periodically devalue their way out of a shortfall in economic productivity as a method of temporarily regaining competitiveness, a policy that is prevalent in Greece’s post-WWII history.
Refusing a bailout would also be in accordance with Article 125 of the Treaty of Lisbon that explicitly states that
The Community shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.
That said, the EU has not been particularly famous for abiding by its own legal framework, which has been repeatedly bent in the past to accommodate “extenuating circumstances” of member states. Sometimes I wonder if anyone even remembers (let alone enforces) the maximum 60% debt-to-GDP clause in the Growth & Stability Pact. Instead, the leaders of the EU might opt out and use instead a loophole in Article 122 that states
EU members states that are seriously threatened with severe difficulties caused by natural disasters or exceptional circumstances beyond its control can be granted financial assistance under certain conditions.
If anyone wonders why Greece will be bailed out in one sort of form or another and disagrees with the thesis, one only needs to look at the origins of the EU and its basic premise. There is an overriding principle behind the euro and it’s not financial but political. Market economists and legal experts can argue all they want on why a bailout will be damaging and illegal, but they are missing the bigger picture.
The EU has its roots in the post-WWII era. It’s a vehicle of expanding French policy in the continent and financing it with German productivity. The European Experiment is above and beyond legal frameworks and economics. It’s about political integration and prevention of World War III. The stakes of this objective are much larger than anyone can read between the lines of the EU Treaties or in economics books.
That is not meant to say that Greece will get a free pass. The Greek government will need to promise and implement (at least temporarily) harsh austerity measures. Concessions will need to be made by an otherwise sovereign nation, but the point remains the same. Greece is on an unsustainable path but the price to pay for the Europeans is small. There WILL be a rescue package of some sort.
Greece might eventually decide that they are Greeks first and then Europeans, and that the euro is not worth surrendering their national fiscal and foreign policy, but this is not something to be discussed in the near future. On a side note, having grown up in Greece, I think that this eventually will happen and Greece will pull out of the euro voluntarily in the face of major protests, failed governments and riots "ala Argentina style...", but we are a few years away from that. This will be purely driven because productivity gains in Greece are small, the country has no manufacturing base and has been dependent on periodic currency devaluations to adjust its global competitiveness in the post-war era up to its entry in the eurozone in 1999.
But in the meantime, the Greek government will try to promise the undeliverable and salvage the face of the coutntry vis-a-vis its European partners. For the EU to let Greece fail without a helping hand would be political suicide. The euro might eventually lose some peripheral players out of their own choice, but Brussels will throw all its resources behind rescuing the euro.
And this is what most economists and legal experts miss. Athens might down the road decide that past glories are more powerful than money in the pocket, but Paris and Berlin will pay any price to keep the core of the European Experiment alive. After all, they both know nobody comes out a winner when German Panzers roll down Champs-Elysees…
This is a revision of my original article on why the EU has an overriding interest in bailing out Greece published under "The Case for Bailing Out Greece"
Disclosure: Author is long the euro (ETF:FXE).