Greek tragedy

May 14, 2012

Greece is stumbling inexorably towards fresh elections which polls suggest will give the anti-bailout far left a stronger grip on power. Last ditch talks aimed at creating a unity government will continue under the aegis of the president today but the leader of the radical leftist SYRIZA has said he will not turn up. Alexis Tsipras says he wants Greece to stay in the euro but will rip up the bailout agreement. Go figure.
This morning the more moderate left party has said it won’t take part in a government lacking SYRIZA.

A big question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that.

Two ECB policymakers —  Honohan and Coene – were out over the weekend talking about the possibility of a Greek euro exit: there goes another taboo. Policymakers must be running through the hard default and exit scenarios now. We need to be asking.

As we’ve said before, Greece has some leverage. The IMF, ECB and euro zone governments are holding a lot of Greek debt so have an incentive to keep the  show on the road or face heavy losses if there is a hard default. Of Greece’s 250 billion-plus euros of debt, nearly 200 billion is now held by those public bodies. It is also hard to see how Europe could avoid propping Greece up even if it did leave the currency club. The calculation for euro zone leaders is whether pouring good money after bad into Greece is more or less palatable than taking a big hit on their Greek debt holdings.

Greece will obviously loom large over this evening’s meeting of euro zone finance ministers in Brussels. But so will Spain. There is talk of Madrid getting some leeway on its deficit-cutting targets after the European Commission predicted on Friday they would be missed. But first it will have to present a more credible 3-4 year plan on how it will get there. So don’t expect anything definitive today.
Spain is grappling with its bad bank debt problem but the 84 billion euros it has told banks to put aside still looks shy of what’s needed. Either government or euro zone money is likely to have to come to the rescue at some point. So far banks have responded with plans that do not require state aid, apart from Bankia which was essentially nationalized last week.

If Spain is cut some slack then why not Greece? (maybe because it has been bailed out twice). Venizelos, the finance minister who negotiated the second bailout, has suggested Athens gets three years instead of two to produce the cuts demanded in its loan programme. If that happened, Portugal and Ireland would presumably demand better terms for their bailouts but it’s not impossible – we’re clearly into policymaking directed at the lesser evil here.

A hefty defeat for Angela Merkel in a key state election on Sunday may not help her bend the rules to keep Greece going. But as regards a euro zone growth strategy — a hot topic this week with Francois Hollande rushing to Berlin for a debut visit — the fact the centre-left SPD, who have argued against austerity for austerity’s stake, cleaned up in North Rhine-Westphalia is interesting.
Another prominent growth proponent, Mario Monti, said on Sunday that Italy’s social fabric is being torn by recession and tensions are growing among its citizens. It looks like there is a growing resolution that the end-June EU summit must come up with more profound growth measures than anything currently on offer. More time to meet deficit targets looks like the obvious option.

An Italian bond auction will provide a test of the threat of contagion from Greece. Up to 5.25 billion euros of debt, mostly three-year, is on offer – the first “periphery” auction since the turmoil that followed Greece’s election a week ago. Demand is expected to be evident and yields could actually fall given the way the market has moved since the last time three-year paper was sold. But there is clearly a risk of something going wrong.
Spain is more in the firing line for now and is expected to pay high premiums to sell 12- and 18-month T-bills.

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