The EU bailout: Too much, too late

By Felix Salmon
May 10, 2010
massive EU bailout a case of "too much, too late"? At $1 trillion, give or take (depending on the highly-uncertain value of the euro), it's certainly enormous: Mohamed El-Erian calls it "a completely new level and dimension" in terms of European policy response. But the late-night negotiations of European finance ministers might yet fail to pass muster with national governments. After all, as Kevin Drum notes, the $700 billion TARP bill was initially voted down by the House of Representatives, and this deal has to be ratified by not one but many different legislatures.

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Is the massive EU bailout a case of “too much, too late”? At $1 trillion, give or take (depending on the highly-uncertain value of the euro), it’s certainly enormous: Mohamed El-Erian calls it “a completely new level and dimension” in terms of European policy response. But the late-night negotiations of European finance ministers might yet fail to pass muster with national governments. After all, as Kevin Drum notes, the $700 billion TARP bill was initially voted down by the House of Representatives, and this deal has to be ratified by not one but many different legislatures.

Meanwhile, Peter Boone and Simon Johnson have some very scary numbers about Greece in particular: it will have to cut spending by a whopping 11% of GDP; its debt-to-GDP ratio will rise to at least 149% of GDP in a best-case scenario; and realistically Greek GDP could fall by 12% between now and 2011. Now that’s a recession.

Meanwhile, Lee Buchheit and Mitu Gulati have a paper out showing just how easy it would be for Greece to default. Buchheit is the godfather of sovereign debt restructuring, and he notes that uniquely among countries in that position, most of Greece’s indebtedness is governed by its own domestic law:

No other debtor country in modern history has been in a position significantly to affect the outcome of a sovereign debt restructuring by changing some feature of the law by which the vast majority of the instruments are governed.

In this context it’s worth noting that Simon Johnson, who used to be the IMF’s chief economist, says that the Fund “floated in some fashion an alternative scenario with a debt restructuring, but this was rejected by both the European Union and the Greek authorities”. What that means is that the idea is being seriously talked about at the highest levels — and that even if the Greek government isn’t going to crack right now, it has a clear “in case of emergency, break glass” Plan B temptingly sitting there for whenever the pain of recession becomes unbearable. With Lazard on board as sovereign advisors, a clear plan of action from Buchheit and the IMF comfortable in principle with a default, the path of least resistance is quite clear.

The obstacles to default would be the Greek banks, which would become insolvent overnight, the Greek pension funds and of course, the EU more generally, which is clearly putting up all these billions today in order to avoid any euro zone default. As Anna Gelpern says, “Greece’s political leverage to restructure may be limited, even if its legal leverage is considerable” — but only insofar as it considers EU and euro zone membership a blessing rather than a curse.

So while the EU’s trillion dollars is surely sufficient to prevent any country from having to default in the next few years, I fear that its enormity will only exacerbate tensions between the euro zone countries over the long term. They’re not all partners together anymore: now they’re bifurcating into the rich lenders, on the one hand, and the formerly-profligate debtors, on the other. The mind-boggling sums involved are only going to increase resentments both of the south in the north and of the north in the south.

Baruch has a great post on this, echoing Philip Stephens:

The Euro is at more risk than it has ever been. And for the new generation of politicians in France and Germany the compromises of the 1990s may not mean so much. We don’t know how much they are prepared to risk to defend the status quo. They don’t have direct memories of firebombed cities, of fathers not returning home, of mothers and sisters raped by the Red Army. I don’t think we’d have the same worry if Kohl and Mitterand were still around. We would trust them more not to f— about. Again, like the ECB, Merkel and Sarko are untried; their being in charge implies less risk, more uncertainty. And the French disengagement on this whole issue worries me.

To recast my matrimonial analogy, the parents have promised to bail their wayward children out of jail. And they think that the children will respond overnight with gratitude and with a fundamental change of behavior. Does that ever actually happen?

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Comments
17 comments so far

I believe the “matrimonial analogy” hits everything on the nail. The rioting in Greece has already testified to that. Amen

Posted by doctorjay317 | Report as abusive

Felix – thanks for pointing out that the original “point” of the Euro was to keep Germans from being raped by the Red Army. I know that sounds sarcastic but it isn’t; there are actually people who thought those two things could be connected.

Aren’t many people in Europe nowadays who are worried about being raped by the Red Army. In fact it’s quite interesting, if you don’t invade Russia the chances of them invading you are pretty low.

Now the Eurozone is being told that they need to come up with $1 trillion to keep the Russians out – or whatever. When in fact what they are doing is coming up with $1 trillion so that “peripheral Europe” doesn’t have to have an exchange rate adjustment. It is a colossal fraud.

As for Greece’s “limited leverage,” what I see is Greece having a bit of trouble meeting a EUR 8 billion maturity on May 19 and the Eurozone reacting with a lending facility that is 100x larger.

If I were Papandreou I would threaten to garbage the “austerity program” and tell Merkel (who is now irreversibly committed) that she either makes up my budget deficit or the Euro is toast – and then the Russians will invade, because [insert sophistry].

Posted by johnhhaskell | Report as abusive

Come on Felix, this is bullshit. Yes, the TARP was voted down first. Then the markets crashed. So Congress got their shit together and voted for it the next time. The pressure would be immense for any european government to do the right thing. The other thing is that the EU is not like a family. It’s more like a gang. So you now have this miserable failed little shit that has wreck havoc with the business. But you can’t waste him, because you protect your own. And the big guys have also screwed up a little bit before so you can’t go medieval without losing face. But the little shit has to pay. Basically, what’s going to happen is that the Greece economy is going to be run by the IMF and a cabal of the major lenders aka ‘the council of the eurozone’, pretty much the way the economy in the baltic states is run by the IMF and the Nordic countries. If you think the Greek numbers are terrifying, try Estonia or Latvia (and don’t get confused by the seemingly low debt level in the baltic states, their banking sector is insolvent, and mostly owned by Swedish banks).

As for riots, so? It’s only going to reinforce the image that Greece needs somebody else that take stewardship over the economy. Also, it makes it possible for the Greek government to deflect blame for austerity measures. And it’s not like Greece can avoid austerity (and more efficient ways of collecting taxes).

Posted by DanKarreman | Report as abusive

Hi Felix. I like your comments, even if you discount to present value everything that could turn nastier. That way of reasonning amounts to none of crisis past could have been overcome…

But I want to stress something: I am strongly opposed to the use of offensive acronyms like the one you (and others)use. Even as metaphors or jokes, that use of derogatory terms contributes to misunderstanding among countries and run against respect and well manners. Things are complicated enough without that abuse of language..

Posted by marcobloom | Report as abusive

Tally-ho, members of the hemlock default coven, yo, wiz at sums etc

Not to disparage all generous backseat and even matrimonial advice dating back it seems to WW2, but what one has learned about TARP and ongoing objections to its recent US iteration is this:

- The way TARP went down in the United States simply isn’t what taxpayer money is for, period. That TARP was an enormous misappropriation.
- Since most of that TARP went into propping up insurance of bad business conducted by bad people who didn’t deserve to be rescued or indemnified but rather prosecuted, rightminded people everywhere hated it.
- Nobody other than prospective beneficiaries ever wants to see another TARP, ever, if it’s anything like the last one.

Ergo, unless Europe is run by raving lunatics, it’s safe to assume that this European proposal probably isn’t just a rehash of the same old US-TARP we know and despise.

And, by the way, enough with the Russians: the only culpable form of Stalinism at the root of Greco-European economic malaise is the version currently observed between Wall Street and K Street.

These Red Ink Army despots and their foolish insurers can however be constructively defaulted on usefully and to resounding applause from other similarly afflicted sovereign states, as well as from everybody else. Targeted default is the solution here.

With Eurozone blessing and a non-contaminated fund to draw from after targeted default, Greece can rationalize and rehabilitate its non-usurious debts relatively smoothly, forever cease and desist from doing business with Wall Street privateers, and move on. Same goes for others in the same boat.

Not just any old TARP, not just any old default and not just eternal austerity – just the right amount of each. Europe is not, after all, a monoculture.

Posted by HBC | Report as abusive

Hoping that Europe will make it and be able to preserve the EU idea as a whole, and assuming that reason will overcome and force European countries to stick together…

Still, Europe is facing the toughest economic period since WWII, as its prospects for economic growth are lower, and there’s a lot of social unrest coming in most member countries – for a variety of reasons.

Anyway, it’s perfectly clear now that it’s no longer about Greece.

Posted by yr2009 | Report as abusive

Wow! Firebombing by the Allies and rape by the Russians. That’s a selective listing of the horrors of WWII!

Posted by ScottFree | Report as abusive

I don’t get it Felix…one day you say that the EU is not addressing the Greek crisis seriously, then when they do, you act like its too late. Then you throw in some totally random analogies about WW2, which barely even connect to your original theme.

I know you are all excited about becoming the next stock picking guru, which is scary enough by itself, considering that the advice you give infers that people should not long term invest in stocks when there is high volatility. Well, if people are supposed to buy low, then a volatile market, with frequent significant lows, is the best time to buy, not when the market is stable and trending higher.

Anyways, back to the original article. I know you are a proponent of a Greek default, and the argument does make some sense. Except that Greece is not Argentina or SE Asia, it is in a shared currency zone. So unless you want to wreck the EU miracle, which pulled the continent out of the stagnant, borderline recessionary environment of the 70′s-early 90s, then a Greek default is not an option.

The EU appears to be heeding calls for a stronger response and more centralized policy. So why criticize their policies when they are doing exactly what they should be doing. A default is a last resort, so why not try every option before sentencing the eurozone to death?

Posted by LucidOne | Report as abusive

The bankers have set the foundation for a global depression by executing the final stage of contagion led by Ben Bernanke the so called ’student’ of the great depression.

In the 80’s the US suffered regional ‘rolling’ recessions and the impacts were faint and regional until investment bankers decided that it was time to leverage companies through ESOP’s backed by inflated DCF models and stocks collapsed in 1987, the Fed encouraged the investment houses to buy up dow futures, this stock collapse did not deter the investment bankers as they leveraged up UAL, the Japanese pulled out and stocks staggered, bankers in their greed to find markets then spread leverage in the 90’s with the holy grail of the internet and removal of financial regulation but this plan was interrupted by 911 when stocks fell, leverage remained in vogue so bankers began leveraging the American consumer through predatory revolving credit agreements then set their sights on the last bastion of American savings…the home equity market. To leverage the vast resource of homes in the US they needed the savings of Europe and the Far East. They did this by fraudulently misrepresenting the credit worthiness of asset backed securities, this was followed by the 2007 debacle.

Now that the current savings of the world have been sucked dry the bankers have set their sights on future generations (sovereign guarantees). These future generations have no voice but through that spoken by today’s citizens who themselves are trembling in fear of their economic lives as bankers remind them that economic order will be devoured if bankers choose to stop supporting global markets…so bankers continue their hunt.

When we are in the midst of the coming depression the times will define what the delusion and the madness of global crowds will do to bankers.

Posted by csodak | Report as abusive

Felix, yes you get all sorts of issues when you start depending too much on analogies…. You are a smart guy so I am sure you will argue appropriately all those comments and hence I will not belabor the point about problematic analogies.

My question is different here. Just because all these parliaments have to approve this new measure, should ECB and finance ministers not propose this plan? We can not blame Europe for not taking bold actions and when it does, then to complain again as too much and too late. I doubt these minsters & ECB would have proposed anything like this without backing of their politicians. Inside parliaments, those members will see that there is a chance to calm markets in this fashion and practically they do not have any other ways, other than to break Euro, to solve this issue. That will make them think twice before rejecting this bailout. For Merkel, electoral damage is done already so she is on board.

To default Greek now for sure is a valid choice as far as Greece goes. But we all know the market run would not have stopped there and the problem would not have solved for Europe. So what is wrong for European Politicians to think all these things in one fell swoop? The other question of competitiveness of weaker economies of Europe is unlikely to be solved in a short time and that is a multi-month task. Question is to buy time till then. That is what this huge bailout is trying to achieve. Further, it is doubtful whether USA would have been able to avoid ‘double dip’ if Euro member countries had started to default.

Felix, you will need to come up with a coherent argument why this bailout is useless and what other strategy would have addressed these issues better.

More on http://www.21stcenturypolitics.com/

Posted by umeshgeeta | Report as abusive

The Greek crisis has developed into a eurozone crisis because policymakers have remained reactive rather than proactive in dealing with the fundamental risks exposed by the potential failure of a member state’s economy.

That Greece represents only 3% of the eurozone economy should give little reassurance. There needs to be a comprehensive review of the way in which countries can be held to account for “creative accounting” and huge divergence from the Maastricht Criteria.

I outlined a few of the key risks in a feature in March:

http://www.fundstrategy.co.uk/features/c over-stories/monumental-risk/1008296.art icle

The failure to address these concerns have been among the main reasons for the continuation of the current crisis and spell danger for the future cohesion of the union.

Greece cannot be treated as a one-off. A bailout without structural reform of the eurozone would set a dangerous precedent that risk in the eurozone is effectively underwritten. I agree with Baruch and Stephens, the euro is facing its most serious test to date.

Posted by tomashirst | Report as abusive

We’re all bankers now.

It’s astonishing the level reckless disregard we have for integrity evidenced in the writings of tomashirst and others. It appears that investors are so caught up in a rapture of fear of losing their investments that they are willing to back up another countries debt and when asked where is your collateral they offer up the servitude of their children and if childless their conscience tells them to reach for their neighbors child.

Posted by csodak | Report as abusive

Speaking as an American,

>>- Since most of that TARP went into propping up insurance of bad business conducted by bad people who didn’t deserve to be rescued or indemnified but rather prosecuted, rightminded people everywhere hated it.

The only exception I take to this is that it was collusion between the political class and these semi-corrupt business interests that caused the problem. Unfortunately, the governing class can not be prosecuted in this instance, but surely some in the business community should be.

>>Ergo, unless Europe is run by raving lunatics, it’s safe to assume that this European proposal probably isn’t just a rehash of the same old US-TARP we know and despise.

This works as an expression of frustration, but is not really true. It is not lunatics that caused the problem but a self-interested political class that put its short term interest ahead of everything else. Given that Europe would seem to be unable to produce a political class that is any better than what resides in the US, another TARP-like solution is not only possible, but likely. In this case it will be a corrupt government rather than a corrupt business class that is bailed out.

Now, can somebody tell me where to put my money before the financial breakdown gets under way?

John

Posted by Johnnyboy00 | Report as abusive

Bad businesses run by bad people who deserve to be prosecuted but is it not the truth that the world simply can not go on prosecuting them if the number of bad men is too many ?There is a limit to the number of people any society can keep in jail .The solution is TARP and other inventions like that !

Posted by mattapparampil | Report as abusive

Let’s play kick the can. Whoever has the most debt goes first. Then kick the debt can as far down the road as you can and hope it doesn’t blow up in your face

http://storyburn.com

Posted by STORYBURNcom2 | Report as abusive

I see that 10bil euros of the first loan to be made to Greece immediately will come from Portugal, Spain and Italy – who also have deficit / debt problems and who also may need a loan. This is robbing Peter to pay Paul! This is crazy!!!

Posted by paulos | Report as abusive

EU Bailout = Lemon

The Bailout in the EU is fundamentally different from the U.S. TARP plan in only one main aspect. There is no lender of last resort in the EU plan, unless you consider the IMF such an entity (which we don’t).

The EU is essentially telling it’s bondholders that they are going to pledge their own funds to bail themselves out. Essentially Germany and France will pay the price, while the PIIGS siphon funds from the stronger body. It’s no different than a group of farmers coming to the bank and saying they’ve decided to merge together and put up funds for the weaker members of the group, due to the drought that has driven the less well managed members to bankruptcy. Maybe the banker will take the bait, and continue to extend financing, but if the drought continued to worsen they’d probably be likely to pull out, and they DEFINITELY wouldn’t offer them funding at a cheaper rate.

Another analogy might be a series of boats tethering themselves together in a storm, rather than anchoring them all to the floor. Perhaps you say the IMF is the anchor in the EU plan? Impossible, because the IMF has committed every last penny of support at their disposal, 250 billion USD worth of special drawing rights, to the plan. The IMF is no more than another flashy boat, maybe better made than the rest, which the group is tying to the sinking fleet of ships.

Therefore the IMF can commit no more funds to any other failing nation in the world without making their EU backstop agreement illegitimate. Go ahead and call it the Europoean Monetary Fund, unless the EU, U.S. and other members add more funds to beef it up… If the CDS and debt markets don’t take the bait, which LIBOR and CDS spreads suggest they haven’t yet AT ALL, we are all in for a global debt crisis of the most severe kind, the SOVEREIGN kind.

So go ahead and do what your uncle Travis has been telling you to do for years… build a bomb shelter and fill it with spaghetti-o’s and hospital masks, because this thing will become atomic in the near future. To stay ahead of the hype and short the crap check out our fresh slice at http://www.diamondslice.com

Posted by TraderRob | Report as abusive
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