While Washington is gripped in an agonizing and potentially lethal game of chicken over the U.S. debt ceiling, the risk of sovereign defaults still remains much higher across the pond, in Europe. Sure, Europe’s leaders are probably feeling good about themselves after finally cobbling together a second bailout of beleaguered Greece last week. They also made some important changes to their approach to the debt crisis that give the euro zone a bit more ammunition to combat the contagion spreading to its weaker members, especially Spain and Italy.
However, anyone who thinks Europe has solved its debt crisis is deluding themselves. Even German Finance Minister Wolfgang Schaüble admitted that “it would be a mistake to think that the crisis of trust in the euro area can be solved by a single summit.” In my opinion, the latest crisis-busting package lacks the muscle to bust much of anything. Here are my six reasons why the euro crisis will still be with us, for a long time to come:
First, the Greek debt crisis is far from resolved. The latest deal is based on too many “ifs” and rosy assumptions that have a high possibility of disappointing. Athens will still have to implement a politically suicidal austerity plan in a politically charged climate, and based on the progress so far (not one public sector employee has been laid off) there is little reason to be hopeful the Greek government can hold up its end of the deal. The idea that Greece will be able to raise more than $40 billion from privatization over a short period is also highly optimistic. Buyers, knowing they’re at an everything-must-go fire sale, will hold out for the best possible prices, and that means low prices. So the holes to plug may end up being larger than expected. And the level of debt reduction the Greeks are getting in this bargain isn’t much of a bargain. It looks like Greece’s government debt to GDP ratio would peak at something around 150% of GDP even after the recent agreement’s debt buyback and bond swap schemes. That’s still an unsustainable level. So after months of effort, the euro zone has put together a second bailout that may only lead to a third.
Second, the latest agreement has done nothing to build confidence in the other weak economies of the euro zone. Borrowing costs for Italy and Spain were back on the rise this week. The future course of the euro crisis will still depend on whether or not Ireland and Portugal can fulfill the reform pledges made as part of their EU bailouts and convince investors to start lending them money again, and even more, the ability of Spain and Italy to repair their national finances and stay out of bailout programs. There are no guarantees that politicians in any of these countries can continue to shove severe sacrifices down the throats of the voting public to preserve the euro. That raises the possibility that more bailouts may be on the horizon. New fears erupted this week that Cyprus could be the next country to require a bailout, after Moody’s downgraded its sovereign rating.
Third, the second Greek bailout may make future bailouts even more likely. The decision to force losses onto private bondholders (though only fair) increases the risk of holding the bonds of other indebted euro zone governments. That means investors will likely demand even higher yields to continue to fund Madrid and Rome, making it more costly for them to maintain access to private capital. It also might make it more difficult for Portugal and Ireland to turn to private investors to fund themselves once their EU rescue funds run dry. In other words, the Greek bailout, rather than putting the brakes on the crisis, might actually have stepped on the gas.
Fourth, the euro zone still doesn’t have the firepower to fight such contagion. Yes, the latest agreement allows the euro’s leaders to use their $1 trillion rescue fund more effectively. But the problem is that many analysts believe it is simply not large enough to give the euro zone’s bark some bite. A chunk of the money has already been committed to the Greek, Portuguese and Irish bailouts, leaving the fund depleted. And with the other troubled economies – Spain and Italy – so much larger, investors won’t be convinced the current fund can achieve much of anything. By one estimate, the fund would have to expand to a lending capacity of $2.9 trillion to do that, but that capacity (net of its commitments) stands at a mere $430 billion now.
Fifth, all of these problems underscore the reality that the euro zone still has no comprehensive solution or approach to solving its debt crisis. Last week’s Greek bailout agreement followed the same pattern as all of the other euro zone, debt-crisis agreements – it was made at the brink of the precipice, and promises more than it delivers. The existing system – combining liquidity support matched to austerity programs – has fundamentally not changed. Aside from tweaking the use of the bailout fund, no new methods were introduced to build investor confidence or shore up the financial standing of the PIIGS (like a Eurobond). The responsibility for saving the euro is still very much on the heads of politicians in Spain and Italy. Basically, the euro zone is fighting its debt-crisis with the same playbook that has proven a loser again and again. Is there any reason to believe that playbook will perform any better in the future?
Sixth, the real problem is that the euro zone is still not addressing its deeper problems. There is no action on the sort of wide-scale economic reform across the zone to foster the growth and investment that would help weaker economies return to health. There is still no acknowledgement that the shaky standing of the euro zone’s banks is at the core of the problem. The leaders of the euro zone have to finally realize that they are not dealing with a liquidity problem, but a structural problem – that won’t go away no matter how much money is dumped into bailouts.
Perhaps the always cheerful Wolfgang Münchau of the Financial Times said it best the other day:
(The Greek bailout) agreement succeeded in staving off an imminent collapse of the eurozone. That is undoubtedly its greatest achievement. But we should not fool ourselves. It will only succeed if it is followed by other agreements that fix its gaps…When the Europeans return from their holidays, they will still have the euro – and they will still have the crisis.