Partying on the Edge of the Eurozone Volcano

The Financial Times has two heated articles (relative to the each writer’s normal emotional register) on the continuing Greece never ending bailout saga, one from Wolfgang Munchau, the other from John Dizard. Munchau and Dizard reach the same conclusion from different fact sets: the latest Greek patch-up exercise is only going to make matters worse, politically and economically.

First from Munchau, who has worked himself up to being shrill on the deal structure, which he compares to a toxic CDO:

If this was any other field of human activity, you would go to jail if you accepted, let alone made such an indecent offer.

This structure is still not quite so complex as some of the more elaborate CDOs we have encountered in the global financial crisis. If you take some time to work through the arrows and boxes, you see relatively quickly that this complex structure is not a private sector participation at all. Rather it is a private sector bail-out.

It is also inevitable that Greece will default on its coupon payment at some point…The complexity of the scheme is due to the need to persuade the rating agencies not to attach a default rating to Greek bonds.

The rollover agreement represents, from an economic point of view, nothing but a collateralised bond. It subordinates all other bondholders. The rating agencies would normally not hesitate to attach a default rating to Greek government debt…

Just why the Greeks would want to accept such a ruinous deal is not clear to me…..The acceptance of the terms of this private sector participation agreement was never part of the agreement with the European Union and the International Monetary Fund. They could therefore simply refuse, and throw the ball back to Europe’s squabbling finance ministers. I doubt they will do this..

Nevertheless, once the treacherous nature of this contraption is fully understood, I would expect the politics of crisis resolution in Greece to become even more difficult, and accident-prone..

We are not just “kicking” any old “can down the road” any more. This is a can of explosives.

Even Dizard, who normally affects a Greene-land savoir-faire and world weariness, has notched up his rhetoric into dismay and ire:

A revenge fantasy invented by the most Europhobic UK Conservative MP could not equal the damage done to the European Union’s reputation by its leadership during the Greek crisis….

Instead, the record of the euro area’s leadership is a sort of anti-Scout Manual of agreements to play with matches in a dry forest and tease nursing bears.

Dizard’s beef is that there are well debugged way of dealing with messes like this, a whole panoply of emerging market defaults and restructurings since the Latin American sovereign crises of the late 1970s. But the officialdom hasn’t merely ignored history but affirmatively rejected it:

One of the negotiators of the original Brady Bond framework told me that he had repeated meetings with eurozone heads and finance ministers, to no avail.

“They all kept saying that Europe was different, that the emerging market experience was irrelevant. It was incomprehensible to me. They have made a difficult situation a hell of a lot worse.”

Dizard contends it was a huge mistake to pursue fiscal stabilization and Eurozone integration at the same time. He is by implication firmly opposed to the brute force negation of Greek sovereignity. As if the asset stripping didn’t make the point clearly enough. Eurozone leaders like Jean-Claud Junker seem to relish the spectacle of a prostrated Greece:

But within hours of Saturday’s decision, Eurogroup chairman Jean-Claude Juncker warned Greeks that help from the EU and International Monetary Fund would have unpleasant consequences. From Reuters:

“The sovereignty of Greece will be massively limited,” he told Germany’s Focus magazine in the interview released on Sunday, adding that teams of experts from around the euro zone would be heading to Athens.

Juncker admittedly tried to sound merely paternalistic with his next remark, but I would not find his comments very comforting if I were a Greek citizen.

Dizard, by contrast, contends that a key lesson of past rescues is to at least maintain appearances that the country on the receiving end of a debt restructuring be seen to be in control of its destiny. Quoting William Rhodes of Citibank, far and away the most seasoned negotiator on this front:

It is imperative that a government be able to present the reform programme as one of ‘national’ origin to avoid the perception that it was imposed, rather than supported, by an outside source, whether the IMF or another political or international financial institution.

Geithner violated this precept in the Asian crisis rescues, which led to simmering resentment and a resolve across Asia never to be at the IMF’s mercy again. The result was that the Asian tigers plus China amped up their mercantilist trade policies, keeping their currencies artificially cheap so they could amass a war chest of foreign exchange reserves. The results were not so favorable to US workers.

Dizard makes a telling remark at the close of his piece:

One gets the sense that what the world’s political and speculative communities want is an excuse for one last, titanic, round of “stimulus” amphetamine. The collectors and dealers I saw last week at the contemporary art sales in London were astonished by the money in the room suddenly looking for something to do. I think they may be seeing the premonition of the mega bail-out to come.

This is 2007 thinking by people who should know better. It was evident that a lot of money managers then knew Things Would End Badly, but assumed they could make it to the exits when the market turned. But liquidity collapsed, and as the rescues attest, most traders were caught still long and wrong. Here it appears we have people one step removed from the action convinced that they can be fleet of foot, and if not, central banks will always watch their back. But the ECB is exhibiting a great deal of rigidity, and in the US, Dodd Frank limits bailout mechanisms. And perhaps as important, austerian thinking is all the rage, which means cheery assumptions about more gazillion dollar emergency measures may prove a tad optimistic.

Unfortunately, it is pretty certain that we will see how the last acts of this nail biter play out. The officialdom has failed to take heed of the warning of general Pyrrhus: “One more such victory will undo me.”

This post originally appeared at naked capitalism and is reproduced here with permission.