Staring into the abyss

The situation in Greece has shifted in the last few days (admittedly a massive understatement), previously the disagreement between the ECB and Germany over a second Greek bailout was the main threat, but with the IMF now agreeing to release the next tranche of the original Greek bailout funds, the main engine pushing Greece towards an imminent default is now the domestic political chaos.

As we've argued before, EU leaders' gamble on the viability of the eurozone was always two-fold: first, that economic forces could be contained (which we all knew they couldn't) secondly, when a crisis hit, taxpayers and citizens would go along with whatever crisis-solution that EU leaders came up with, be it bailouts, EU-backed austerity measures or closer fiscal union.

On the economics side - as we've argued since the idea of eurozone bail-outs were first being discussed last year, a one-off rescue package for Greece was not going to work. In a paper published in February this year,we argued that:

"Greece’s situation is simply unsustainable. This year, Greece needs to find at least €53 billion just to avoid increasing its already massive debt. Even in a best case scenario and with the help of foreign taxpayers, Greece is set to fall short of these targets. The numbers simply do not add up and some sort of restructuring – or additional help – therefore seems inevitable."

This is where the second big gamble kicks in - how far can you push electorates in both debtor and creditor countries, before something gives in? Media across Europe is now awashed with images from the Greek protests and stories about the political chaos that has hit its governing class with with full force. Like any other gamble, the outcome of EU leaders' bet on social, democratic and political forces being possible to contain is shrouded in uncertainty.

So what about the options on the table? Well, next week, Open Europe will publish a briefing detailing the EU's exposure to Greece (through various channels) and the potential costs and implications of a second bail-out. Again, as we've argued for a longer time than most, a full debt restructuring is emerging as the only viable option.

At the moment, two options are being discussed for involving the private sector in the second bailout, although neither goes far enough and looks unlikely to make any long term difference:

Bond rollover - Offers private bondholders, who hold debt maturing in the next few years, the chance to purchase new longer term debt. This option is backed by the ECB and France since it is completely voluntary and would not be viewed as a default by the rating agencies. The main problem is, why would any bondholders agree to this? It comes down to whether they believe that the EU/IMF will let Greece default if they do not take part. Even if a substantial number of bondholders agreed, it would only relieve the pressure for a short amount of time.

Bond swap - Offer private bondholders the chance to swap out their current bonds for those with longer maturities (7yrs has been discussed). Originally viewed as voluntary but rating agencies have made it clear that this would be judged as a default. Same problem as rollover, why would bondholders commit? Also significant disadvantages from being judged a default (no more ECB liqudity for banks etc).

Although the reversal by the IMF is welcome in the sense that it avoids Greece defaulting in a disorderly manner next week, the underlying problem remains. A second bailout will not solve any of Greece's problems but will merely delay the problem and will mean that when the eventual restructuring happens more debt will be in official hands (EU/IMF/ECB), furthermore it will simply be renewing and extending the massive gambles which the EU took with the original bailout, clearly that lesson has not be learnt.

And the situation is getting tenser. This morning, Swedish Finance Minister Anders Borg - whose country just like the UK and virtually any other economy (apart from perhaps North Korea) will take hits should Greece default - said that the Greek opposition's refusal to enter a national unity government borders on “criminal irresponsibility.”