Europe’s Last Chance to Let Greece Default

Once European nations agree to a second financial rescue package for Greece, there’s no way back.

European governments have mere weeks to decide whether to let Greece default or commit to a long-term financial rescue operation of the country. If their parliaments enact a second, €109 billion bailout for Greece this month, which includes billions worth of contributions from the private sector, they cannot afford to backpedal on the pact anymore without undermining confidence in financial markets.

The eurozone’s political leaders agreed to another Greek bailout in July after the €110 billion committed last year proved insufficient to steer the troubled country off the brink of bankruptcy.

With more than €340 billion in debt, Greece is now among the least creditworthy of nations. Nearly one out of ten Greek workers is unemployed and its economy is expected to contract by up to 5 percent this year.

The specter of default does not appear to have engendered a particular willingness on the part of the Greek people to reform. Although subject to heavy austerity measures, including public-sector pay cuts and pension reductions, reining in the pervasive Greek state is unpopular.

Government spending accounts for almost half of the Greek economy and the state maintains ownership in airports, casinos, hotels, resorts, railways and utilities. Many of these enterprises are wholly unprofitable and need thorough reforms before they can go to market.

Greece’s powerful trade unions are another obstacle as they oppose a planned liberalization effort. Athens has promised to net €50 billion through privatizations but consistently falls short of its short-term financial targets. Just last week, representatives of the European Commission, the European Central Bank and the International Monetary Fund suspended their evaluation of Greece’s austerity program in anticipation of revised budget plans. The last of six multibillion euro aid tranches hinges on their approval. Without the necessary consent, Greece would soon lack the funds needed to service its existing debt obligations.

Contrary to the original aid program, the second bailout is supposed to involve banks and insurance companies that have invested in Greek bonds. They would be persuaded to accept rollovers on Greek debt which could buy Athens time to get its fiscal house in order.

If the new plan is approved by national parliaments this month, roughly two-thirds of Greek debt would ultimately be owed to other European countries and the IMF. If Greece were unable to repay all of its loans despite the attempted rescue — considering the slow pace of reform, that is a real possibility — it would probably not renege on its obligations to other members of the euro area, thus forcing private bondholders to accept huge losses. Banks and pension funds across Europe might be better off if there were a selective default now.

There is opposition among nationalist and conservative parties in Austria, Finland, the Netherlands and Slovakia to continuing to pour money into Athens’ coffers. The Slovaks actually voted against the first bailout after they joined the euro in January 2009.

As the malaise in Greece continues, there is talk of simply kicking it out of the eurozone. A Greek exit from the currency union would imply major losses for bondholders however and probably not alleviate its debt burden. Nor would Greece be capable of regaining competitiveness and growth without enacting the very reforms on which its international support is conditioned. A new drachma could boost exports in the short term but superfluous regulations and red tape do far more to impede foreign investment and trade than the value of the euro ever has.

A revived national currency would tempt policymakers in Athens to inflate their way out of debt moreover. With or without the euro, bondholders will suffer losses unless European governments are willing to bear the burden of financing Greek deficit spending for years to come.