In euro’s moment of destiny, bold may not be bold enough for Greece

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Eurozone leaders will meet in Brussels on Thursday for an emergency summit whose main aim will be to agree on a second bailout package for debt-burdened Greece as it becomes increasingly obvious that the current system of providing interest-bearing loans to Athens in return for austerity measures and structural reforms is not viable for much longer.

The summit is shaping up as a pivotal moment in the single currency’s history because in attempting to address the Greek situation, eurozone leaders are set to adopt unprecedented measures that could pave the way for a much more radical and comprehensive approach to the debt crisis.

“There are times in history when it really matters,” an unnamed European diplomat told the Financial Times. “This is one of those times. The people working on a comprehensive package feel the weight of their responsibility.”

One of the suggestions on the table for Thursday’s meeting is for the European Financial Stability Facility (EFSF), a rescue fund created in the wake of the Greek crisis, to lend money to Greece at favorable rates so Athens could buy back its bonds from private creditors at market prices.

Many in the eurozone favor this idea as it would ease Greece’s debt load – reports in Germany suggest Athens would save 20 billion euros – without triggering a default and would not involve the kind of fiscal transfers that worry some of the eurozone’s core countries.

In an interview with To Vima newspaper, European Central Bank executive board member Lorenzo Bini Smaghi said that using the EFSF to provide Greece with funds to buy back its bonds would be “a useful option.” “This would allow the private sector to sell bonds at market prices, currently below nominal value. At the same time, the public sector could benefit monetarily,” he said.

Another proposal put forward by Germany is for Greece to exchange its bonds for ones that mature over a longer period. But this would probably have to involve private investors taking a haircut, thereby triggering some form of default. The ECB has vehemently opposed any proposal involving a default, fearing the knock-on effect this could have in other parts of the euro area and on European banks in particular.

However, the key problem with the bond buyback scheme is that it is unlikely to be enough. Even when added to further emergency loans from the eurozone and the International Monetary Fund, and the early release of structural funds, it is doubtful whether the package will help Greece wriggle out from under its debt mountain, currently at about 350 billion euros. The IMF forecasts that Greece’s debt could reach 172 percent of GDP next year, while the ECB predicts that it will peak at 161 percent in 2012. Both forecasts suggest that a much more radical solution has to be sought and that any agreement reached on Thursday will just be a sticky plaster over Greece’s debt wound that will buy a little more time for everyone involved.

A number of alternatives have been put forward over the last few weeks. Daniel Gros, the director of the Center for European Policy Studies, a think-tank in Brussels, proposed in an article in the New York Times last month a bond buyback scheme with the EFSF offering private investors the opportunity to exchange all Greek paper for EFSF paper at market prices.

Gros wrote: “The EFSF could then be the only remaining creditor of Greece and propose a bargain to the country: ‘We write down the nominal value of our claims (say, 280 billion euros) to the amount we paid (say, 150 billion euros) and extend all maturities (at unchanged interest rates) by five years provided you (Greece) agree to additional adjustment efforts (and asset sales).’”

This would save Greece 130 billion euros and a more manageable public debt of less than 95 percent of GDP, Gros argues.

Greek economist Yianis Varoufakis and colleague Stuart Holland have seen Gros’s proposal and raised it. They suggest that the value of Greek bonds will rise if the EFSF makes it known it is in the market for them, thereby dampening the debt-reduction effect. Instead, they put forward the “Modest proposal.”

They recommend a substantial tranche of Greek debt be transferred to the ECB to be held as ECB bonds, allowing Athens longer to repay what it owes. They also call for the recapitalization through the EFSF to cleanse the banks of questionable public and private paper assets. Under the proposal, the European Investment Bank (EIB) would launch a “New Deal” for Europe, drawing upon a mix of its own bonds and the new Eurobonds, to drive investment.

Building on this final element, Barry Eichengreen, a professor of economics and political science at the University of California, proposes “a multi-year program of foreign aid” or “New Marshall Plan.” “Foreign aid and expertise could be used to modernize the property-registration and tax-collection systems,” Eichengreen wrote last week. “Funds could be used for recapitalizing the banks and retiring some debt. They could help finance government support for the unemployed, indigent and elderly, who are among the principal victims of the financial crisis.”

These are all suggestions that deserve a closer look, but there are two key obstacles to agreement on such comprehensive plans.

Firstly, Greece has not yet convinced its partners that it is eradicating the waste, corruption and inefficiency that helped cause the current crisis. In an interview with Bild am Sonntag newspaper, the head of Germany’s Bundesbank, Jens Weidmann, said: “Greece consumes considerably more than it produces, the state budget is in high deficit.

“As long as none of this changes, even cutting the debt would not produce a real improvement,” said the central banker. If Athens cannot convince key players like Weidmann, who is also a policymaker at the ECB, that it is doing its fair share, then a comprehensive solution will never materialize.

The other obstacle is political. The debt crisis has made leaders of the core eurozone countries balk at the prospect of having to explain to taxpayers that they will have to provide further loans or help to debt-laden members. However, as more countries become caught up in the crisis, the balance may tip in Greece’s favor.

It was significant that last week Giulio Tremonti, the finance minister of Italy, a country that had until recently evaded the clutches of the debt crisis, pleaded for Europe’s politicians to be bolder. “Today in Europe there is an appointment with destiny,” he said. “Salvation does not come through finance but from politics. But politics cannot make any more mistakes.

“No-one should have any illusions of individual salvation. Just like on the Titanic, not even the first class passengers will be saved.” For now, Greece would settle for those buffeted about in second class being thrown a lifeline.

Nick Malkoutzis

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