The Great Debate

By Mohamed El-Erian
This piece is the English version of the one that appeared in Handelsblatt. The opinions expressed are his own.

Not a day goes by without a flood of comments on Greece and its debt problems. They seem to come from everywhere. Some are later denied while others are left to stand, accompanied by a continuous string of worrisome data. In the process, even greater disorder is gaining hold of the country’s debt markets, with credit spreads exploding in an ever more alarming fashion.

There is a risk that all this could serve to confuse rather than illuminate the key issues that should be on the radar screen of many, whether they are policymakers or normal citizens. I can think of five such issues.

First, there is a good reason why Europe’s current approach to Greece’s problems has not worked well. Indeed, many, including me, believe it will not work any better going forward. Meanwhile, the costs and risks are growing exponentially.

Despite a year of large sacrifices on the part of Greek society and exceptional financial support from neighbors, Greece is still very far from regaining economic and financial stability. Output continues to collapse, unemployment is rising, the budget deficit remains alarming, and the already excessive debt burden is increasing further.

Ireland's fall from grace has been rapid and far worse than that of its counterparts, even Greece. But life in the euro zone has still been one of profound growth, as it has for most of the other peripheral economies.

Take a look first at the progress of  PIGS (Portugal, Ireland, Greece and Spain) GDP since 2007 when the global financial crisis took hold. In straight comparisons (ie, rebased to the  same point) Ireland is far and away the biggest loser. Portugal is basically where it was.

But now take the rebasing back to roughly the time that the euro zone came together.  First, it shows that Ireland's fall is from a very high place. The decade has still been one of profound improvement in cumulative GDP even with the last few years' misery. But it is front loaded.

-Laurence Copeland is professor of finance at Cardiff University Business School. The opinions expressed are his own.-

Back in the 1950’s, when most women stayed at home while their menfolk went out to work, a favourite trick of life insurance salesmen was to walk into the prospect’s home at dinner time and ask the wife:

“Mrs Smith, have you ever thought what would happen if your husband keeled over and had a heart attack right now?”

Fear of lending to banks is rising again in Europe, as even a 750 billion euro zone rescue package proves not enough to stem fears that the banking system will prove the weak link when southern European nations can’t meet their obligations.

Strikingly many European and British banks are now being forced to pay more to borrow money in the interbank markets than before the joint European Union, International Monetary Fund and European Central Bank package was announced two weekends ago.

That deal, which should insulate highly indebted countries such as Greece, Spain and Portugal from funding pressure for the next two years or so, was effective in driving down the extra interest those countries had to pay to borrow as compared to Germany. Tellingly, it was less effective, even counter-productive, in restoring calm to the markets in which banks fund their short-term borrowing needs.

If government debt is the new subprime, it may just turn out that Greece is a Florida condo while the United States is a single-family house in a nice mid-Western suburb, the kind of place that fell 15 rather than 50 percent.

In considering the Greek, or European, sovereign debt crisis, the common line of argument, which is true if incomplete, is that the U.S. is far more different than similar; it possesses its own currency, which just happens to be the world’s primary reserve unit, its economy is stronger and more flexible and its institutions better developed and more credible.

All true, but there is a funny feeling that investors, prompted by Greece but also having looked at better credits like the U.S., are doing a fundamental reevaluation of the risks of lending to governments. This may end at Greece, it may end at Portugal, it may end at Britain, but it is not over yet.

Europe desperately needs to get out in front of its solvency problem, Greek edition; not because it is right, not even because it will work in the long term, but to stem rapid and costly contagion through financial markets to other weak links in the euro zone, not least to banks.

Whether euro zone institutions will have the agility and resolve to quickly put in place out-sized measures for Greece is doubtful.

That Greece on Wednesday was paying more than 20 percent, or about double the rate of Hugo Chavez’s Venezuela, to borrow money for two years showed that investors were expecting either a default or very large burden sharing by existing creditors, and possibly a, by definition, disorderly exit from the euro by Greece. Spain joined the list of sovereign downgrades, as Standard & Poor’s cut its rating a notch to AA, a day after the debt rating agency slashed Greece to junk status and cut Portugal to AA.

Stock up on canned goods, the authorities appear to be opening a new front in the War Against Speculation; this time taking aim at the people who might profit from Greece and its European partners’ woes.

Just days after the U.S. Securities and Exchange Commission voted new limits on short selling, Germany is investigating the credit default swap trading of speculators to try to prevent them from profiting from any bailout of Greece.

“It would be bad if it were to emerge after a rescue that the money had gone into the pockets of speculators,” a source with knowledge of the efforts told Reuters.

Goldman Sachs has a lot to be thankful for – huge bonuses, massive taxpayer subsidies, unrivalled political influence – but in Greece they have finally found nirvana: a highly profitable business partner who can also credibly serve as the villain in the piece.

Goldman is widely reported to have arranged a swap transaction for Greece early in the last decade structured in such a way as to provide the country with $1 billion upfront in exchange for higher payments much later.

That later bit is key – it helped to mask over-borrowing by Greece from the euro zone’s budget watchdogs in Brussels, not to mention from Greek taxpayers and the buyers of Greek debt, all of whom have a right to fully understand the risks of a country incurring liabilities which perhaps it may struggle to repay.

The drama unfolding in Athens contains all the usual ingredients for a modern crisis. Poorly disclosed derivative transactions. Inadequate accounting for off-balance sheet liabilities. Investment banks eager to structure complex transactions in return for fat fees. And a furtive but gullible government that thought it could get something for nothing.

Life is a lottery; some loans go wrong in the ordinary course of events. But behind every really bad loan or class of loans, like subprime mortgages, there are greedy and foolish bankers and equally culpable borrowers. Greece is no exception.

The Greek state has only itself to blame for manipulating accounting rules and derivatives markets to run up unsustainable debts. But the banks that structured those transactions are hardly blameless and cannot really complain if they do not get all their money back.

– James Saft is a Reuters columnist. The opinions expressed are his own. –

As odd as it sounds, concerns about the effects of a euro zone sovereign crisis on Europe’s still poorly capitalized banks may prove to be the tipping point that leads to a swifter bailout of Greece.

While discussion of contagion may seem very 2008, the problems with Greece, which faces a huge fiscal deficit, are becoming tougher for euro zone authorities to leave uninsured.