27.07.2011

Facing debtgeddon

Greece has defaulted in all but name and the US treasury is only days away from running out of funds. Eddie Ford looks at the ongoing crisis

As readers will know, after what amounted to an emergency meeting of the euro zone leaders in Brussels on July 21 - described by one participant as the “most chaotic summit ever” - the inevitable happened and Greece received a second bailout. Either that or let the country slide into total economic annihilation, thus threatening the entire euro zone project - or worse. Unthinkable. The total contribution from the European Union and the International Monetary Fund, via the European Financial Stability Mechanism, will now rise from the €110 billion agreed last May to over €200 billion. Of course, given that Greece’s total debt stands at €355 billion, and is getting bigger every day, this is like putting a sticking plaster over a gaping wound. But, as panic spread, a quick fix seemed better than no fix.

In a move to further assuage market anxiety, the summit leaders also announced a major overhaul of the EFSM’s €440 billion bailout fund, substantially easing the terms of rescue loans. Significantly, from now on the beefed-up EFSM mechanism will be able to assist countries that are not technically in a bailout situation through “precautionary” credit lines and by giving it the ability to recapitalise any struggling bank in the euro zone. Obviously, this expansion of the EFSM’s powers was carried out with Spain and Italy in mind, as a preventive measure against the dreaded contagion. All hands to the euro zone deck. In some respects, this is tantamount to the creation of a European Monetary Fund. Some have even described the new EFSM as a modern-day equivalent to the Marshall plan, though maybe more in hope than expectation.

Anyway, to break down the various figures arrived at in Brussels is not an entirely straightforward task. As one EU commission official admitted, they include a lot of “estimates” and “assumptions” - or wishful thinking to you and me. Essentially, the new money is €109 billion in loans from the euro zone and the IMF to be dished out over the next three years; of which €20 billion or so is to be used to buy back Greek bonds and another €20 billion to recapitalise Greece’s banks. The €109 billion figure includes an estimated €28 billion which is supposed to come from the proceeds of privatisation.

However, if Athens fails to deliver on this - whether as a result of determined resistance from the Greek workers’ movement or some other reason - then the euro zone/IMF will need to step in to make up the difference: in other words, give the Greek government another ‘mini-bailout’. Must keep the show on the road. Furthermore, the Greeks will get an additional €45 billion on top of the €109 billion in the shape of the euro zone/IMF loans still left over (or waiting to be paid) from last year’s initial €110 billion bailout, and which to no-one’s surprise proved to be inadequate. Needless to say, the new Greek loans will be offered at lower interest rates - at around an average of 3.5% - and the repayment periods will be extended from 7.5 to anything up to 40 years (these new loan conditions will also be applied to Portugal and Ireland). Almost on the never-never, you could say. If only ordinary Greek workers or small enterprises could get a personal loan on such generous terms.

Perhaps more contentiously, or dubiously, private creditors (banks, insurance companies, pension funds, etc) are expected to contribute €50 billion to the debt relief plan. This will involve around €37 billion in assorted bond rollovers/swaps and a projected €12.6 billion or more in the form of debt buybacks, enabling Athens - at least in theory - to ‘retire’ debt at heavily discounted prices. It almost goes without saying that the envisioned private sector rollovers and swaps, just like the sparkly new restructured loans to the Greek government from the euro zone/IMF, will be offered at lower interest rates - something between 4% and 5% - and have longer maturities in the region of 15 to 30 years. Which, of course, is bad news indeed for the private investors/speculators who under these proposals are supposed to take a ‘hair cut’ - ie, make a loss.

Overall, it has been roughly calculated that these various bondholder programmes will lead to a 21% reduction in the bonds’ value; a substantial hit in anyone’s books, let alone profit-hungry investors. Even more to the point, the credit rating agencies - cardinally the terrible triumvirate of Moody, Fitch, and Standard and Poor - will regard such a development as Greece defaulting upon its current debt obligations. Fitch has already announced that this will indeed be the case and that - barring a miracle - Greece will get ‘officially’ classified as a defaulter some time over September-October when the new terms and conditions for the private creditors start to kick in (ie, get worse). Naturally, the same for Moody’s, who bluntly stated that the likelihood of a Greek default is “virtually 100%”, and expressed deep concern that Greece’s “stock of debt will still be well in excess of 100% of GDP for many years”, meaning it “will still face very significant implementation risks to fiscal and economic reform”.

Therefore, no flies on the euro zone leaders and officials, they also announced at the summit that an extra €35 billion will be made available as “collateral support” to the European Central Bank when Greece is declared to be in “selective” or “restricted” default - to use the more up-beat EU-speak. Similarly, euro zone representatives optimistically maintain that this ‘managed’ default will be extremely “short-lived”, so that the collateral support fund will remain untouched - fingers crossed. Equally, and hardly surprisingly, the euro zone leaders have been at pains to insist - in a bid to avert wholesale private investor panic - that the bondholder ‘hair cut’ would be limited to Greece.

Yet it is clear that the Greek bailout is built largely on sand, especially given that private sector participation is, of course, voluntary and largely predicated on the ‘pledges’ - if you can call them that - presented to the summit by the International Institute of Finance, which represents the main private bondholders. Hence, as things stand now, no-one really knows who exactly will deliver what exactly and when. Yet even if all the debt buybacks, rollovers, swaps, etc actually happen in the way they are supposed to - a highly dubious proposition - Greece’s level of debt come 2014 would still only have been cut by some €26 billion (barely 13% of the total). In purely cold-hard fiscal terms, the current debt situation for Greece is simply unsustainable - suggesting that there will be more bailouts and handouts, call them what you will, in the not so distant future. Furthermore, as if things did not look hopeless enough, all of the 17 governments and parliaments of the euro zone have to endorse the bailout deal for it to go through. Slovakia, to name just one, has already intimated that it could lead a revolt against the agreement.

Despite everything though, the spectre of contagion refuses to be banished. Rattled by recent events, the markets delivered their preliminary verdict - by sending Italian and Spanish bond yields back to the levels seen before the July 21 second bailout; meaning, of course, that the borrowing costs for these two countries sharply rose. That in turn increases the chances that Spain and Italy will be plunged sooner rather than later into a calamitous sovereign debt crisis of their own that could dwarf the problems faced by Greece, Ireland and Portugal - all of which at the end of the day are minor players in the euro zone drama. Such market volatility is an ill omen for the euro and the EU as a whole.

Catastrophe

Whatever the best laid plans, or otherwise, of the euro zone bureaucrats, catastrophe looms across the Atlantic. A catastrophe that is sketched in for August 2 and could send the euro zone, and the world, into a potentially unrecoverable financial/economic tail-spin, no matter what happens in Greece, Portugal, Ireland, Spain, Italy, etc.

As the Weekly Worker goes to press, the stand-off between the Democrats and Republicans in Congress over the debt limit has not been resolved - though a debate on the legislation, and a possible vote of some description, is to be held on July 28. Indeed, if anything, the acrimony and bitterness has escalated over the last week, with the Democrats and Republicans warring over rival debt plans. Barack Obama has called for a “balanced approach”, to which John Boehner - the Republican speaker of the House - responded by saying that what Obama wanted was a “blank cheque”, whereby Washington gets to “spend more and you pay more” and impose tax increases that “will destroy jobs”.

Looking haggard, Obama at the start of the week appeared on prime-time television to warn that the Republicans’ so far utterly unyielding approach to the US debt crisis was a “dangerous game” and called for a spirit of “compromise” - on both sides. Yet the reality is that in the squalid battle to resolve the impasse, one way or another, Obama has agreed to large chunks of the Republicans’ Tea Party-inspired slash-and-burn programme, which would see the very poorest hit the hardest (Medicare, Medicaid, etc) and the wealthy retain their tax perks and benefits. To such an extent that many Democrats feel betrayed by Obama’s attempts to bend over backwards for the Republicans and their ever shriller demands. So on July 26 the Democrats’ Senate majority leader, Harry Reid, challenged the Republicans to back his own plan - which involved no tax rises at all, but government cuts coming to some $2.7 trillion over a decade. The essential Republican programme in all but the fine detail.

But that was not enough for the “rightwing nutters” in the Republican Party, as Vince Cable not inaccurately described them. No way. In fact, the crazies - just like the ‘left’ Democrats - are also sensing betrayal, raising violent objections to Boehner’s suggestion that the $14.3 trillion debt limit be temporarily lifted for six months: no surrender. Summing up the Republican mindset, Congressman Dan Burton informed Al Jazeera that Obama “believes in a socialistic, European-type, socialism approach to government” - because he wants to “put more of a burden on the taxpayers”. Yes, rightwing Republican suspicions have been confirmed: Obama is a crypto-socialist or worse, and some of the senior Republican leaders might well be pinko fellow-travellers as well. Civil war beckons for the Grand Old Party?

However, Boehner’s idea of temporarily raising the debt limit was too much even for Obama, who - not without logic - likened it to “kicking a can down the road”: that is, it amounted to sticking your head in the sand and hoping the debt problem will magically go away. Forget it. Showing the extreme seriousness of the situation, with the Democrats and Republicans polarised as never before, for all of Obama’s backsliding to the right, the White House on July 27 issued a terse warning, saying that the president might well veto the House Republicans’ debt limit proposals when they are fully unveiled the next day (or whenever).

Yet the clock is ticking, and if an agreement to raise the US debt limit - or some other sort of deal - is not reached by August 2, then the US will suffer a catastrophic default and the US treasury will run out of money to pay ‘non-essential’ bills and wages (schools, parks, libraries, etc). An occurrence that would have seemed unimaginable only a few months ago. Such a default would lead to interest rate rises and, disastrously, the possible downgrading of the US’s triple-A status with the credit rating agencies - according to Standard and Poor, there is a “50-50 chance” of that happening over the next few months. Such an eventuality could send the entire US economy into a deep recession, and would set off an almost immediate global chain reaction effect: it could even herald an unprecedented economic slump. Thanks to the dual debt crisis, we are now facing what some have called ‘eurogeddon’ and ‘dollargeddon’. They might not be exaggerating.

In which case, British chancellor George Osborne can wave goodbye to his ‘recovery’ plans - already turning to dust. The preliminary GDP estimate for April to June showed the economy growing by a mere 0.2%. Although this was slightly better than some of the gloomier forecasts, it is rather lower than the 0.5% growth seen in the first quarter, which came after a 0.5% decline in the fourth quarter of last year. Rather unpersuasively, to put it mildly, the Office for National Statistics attributed some of the “weakening in growth” to a range of one-off events: the royal wedding, the additional bank holiday, the unusually warm April, the impact of the Japanese tsunami on global supply chains ... Excuses, excuses - not for nothing has Ed Balls, the shadow chancellor, accused Osborne and the government of being in a state of “total denial” about the economy.

As a consequence, City economists and various think-tanks warned that the grossly misnamed Office for Budget Responsibility would have to “revise down” its 1.7% growth forecast for this year. Credible rumours are circulating that there is a rift developing between Osborne and Cameron over how to “kick-start” the economy, with the chancellor like a stuck record arguing for tax cuts to an increasingly unimpressed prime minister. Maybe Cameron is beginning to realise that Osborne might not be such a financial/fiscal genius after all.

More ominously still, US-style fears are growing that Britain could lose its triple-A status too unless the economy picks up sharply in the third quarter. All the signs are that the UK is slipping into a double-dip recession, courtesy of the coalition government’s suicidal austerity plan. But Osborne, of course, has no plan B.