If Greece’s debt dam breaks, who gets wet?

April 13, 2010

The 16 countries that share the euro single currency have agreed they will help Greece out if it needs. So far so good. But only now is the nitty-gritty of how member states will go about paying for their contributions being hammered out. And suddenly things are getting a little complicated.

Italy announced on Tuesday it would have to issue government bonds — known as BTPs –  to raise funds for its part in any Greek assistance. 

Under the agreement finalised by euro zone members on Sunday — by which they will provide about 30 billion euros to Greece if needed, and the IMF a further 15 billion euros — Italy may be called upon to disburse about 5 billion, a figure proportional to its economic weight in the euro zone. Germany, the European Union’s biggest economy, would have to provide a little over 8 billion euros. 

If Italy, which already has national debts in excess of 100 percent of GDP, issues more debt to raise money to help Greece get over its debt problems (Greece has a debt-to-GDP ratio of 120 percent),  then, in theory, the yield on Italian bonds is likely to rise as investors factor in the increased risk. And since almost all members of the euro zone have severe budget deficits (and therefore little free cash), potentially all of them are going to have to issue more debt to raise the funds to pay Greece to overcome its even more serious deficit problems. It’s spreading the risk around.

By the same token, if Greece asks for and gets the help it needs, its bond yields can be expected to fall if investors (or speculators) believe that the worst of the crisis is over and that the risk of a Greek default has now passed.

Multiply that scenario across the 16 members of the euro zone and what you get — again, in theory — is the risk profile of 15 member states increasing slightly in order to allow the 16th member, Greece, to lower its profile. It’s like the water in a vast dam being released to save the one village next to the lake, with the result that all the villages in the valley get flooded equally.

Extending the metaphor, Germany, which doesn’t get flooded very often and has taken sensible precautions against such an outcome, clearly doesn’t like the idea of getting wet at all and has promised to keep its villagers dry. Italy doesn’t mind getting a bit wet because it’s been flooded a few times before and it might need the help of the other villages in the future. France, which likes to be seen as the driving force of inter-village cooperation, thinks it’s the responsibility of everyone in the valley to take on a bit of a water to help out the village by the dam — Greece. And meanwhile Greece, which was responsible for putting most of the water behind the dam in the first place, just wants to make sure it doesn’t end up completely inundated, even if that means its neighbours taking a bit of a dousing in the process.

The extra complication as to whether such a scenario plays out is whether the village councils — all of whom must decide together whether to allow Greece to open the floodgates — will agree to a small soaking.

In that vein it was notable that the Italian parliament — which arguably isn’t one of the world’s most efficient assemblies — may have to decide if Italy is allowed to contribute to a Greek financial aid package. If that’s the case, releasing money to Greece could take far longer than anyone expected.

Given that the floodwaters behind the dam are still rising and the dam wall itself is beginning to show cracks, euro zone members might want to decide quickly how many bailout buckets they have available and make sure their particular village council is going to let them use them.

4 comments

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The EU is all Greek to me. Interactive Google Map on the EU 27 public and private debt: http://bit.ly/a0gxOF

Posted by derwin | Report as abusive

Will Greece have to participate in the bailout of Italy, Ireland, Portugal, and Spain? There seems to be a logical flaw here…

Posted by traderjoe10 | Report as abusive

“One World One Order” doesn’t seem to be working-out too well for the European Union! England was very smart to avoid involvement.
I believe that it not the governments of the countries that will suffer in the long run but the individual, particularly the investor.

Posted by no1stockoptions | Report as abusive

England didn’t need join because they are owned by America.

Posted by charluca | Report as abusive

[...] To get a better sense how crazy this is, read the following, which I saw Monday early morning on a Blog from Reuters: [...]