Europe to Save its Banks, not Greece

by Floyd Norris
NYTimes
February 10, 2012

It now appears that Europe is prepared to pay what it needs to pay to save its banks.

But not to rescue Greece.

Once again, there is optimism that a new round of European talks are going to result in an announcement of a Greek bailout. On Thursday, the Greek political parties caved in and agreed to a new austerity package that will satisfy the latest European demands.

When other loose ends are tied up, it appears the Greeks will have given up their principal bargaining chip — the threat that if they are allowed to collapse, they will take the European financial system with them.

If that happens, then at some point down the road, when it turns out that Greece has again fallen short of its deficit reduction targets, Germany will again demand more sacrifices. If the Greeks refuse, then the rest of Europe could be in a position to let Greece go.

It might or might not stay in the euro zone, but a bankrupt Greece would be left to fend for itself, with much of the rest of Europe saying — just as it did two years ago, when Greece’s distress was just becoming clear — that it is a small country of little importance to the rest of Europe.

Perhaps Europe, in its stumbling and sometimes disorganized fashion, will have accomplished a large part of what it set out to do. It will have put a fence around the Greek tragedy and preserved — most of, if not all — the euro zone. As for rescuing Greece, well, you can’t win them all.

The current European attitude was best captured by a document that was circulated as part of the now-abandoned German proposal to force Greece to accept a “budget commissar” to supervise its spending.

“Greece has to legally commit itself to giving absolute priority to future debt service,” said the document, said to have been circulated by German officials. “State revenues are to be used first and foremost for debt service.” Whatever money was left over could be used for other purposes, such as paying police salaries or purchasing hospital supplies.

That was shot down because it sounded so undemocratic and authoritarian, said Whitney Debevoise, a partner in Arnold & Porter with long experience in international bond negotiations. “Plan B is the escrow.”

Escrow does sound like something neutral. But it apparently means the same thing. European aid to Greece would go into an escrow account, to be released as Europe saw fit and withheld if Greece again failed to live up to its promises to cut its budget deficit. But of course the money would be released for debt payments on the restructured bonds. For at least a few years, banks and others that own the new Greek bonds would be assured of collecting their interest payments.

“The euro area will be able to call the bluff of the Greek government,” said Jacob Kirkegaard, an economist at the Peterson Institute for International Economics.

“Greece says, ‘If we default, all hell breaks loose,’ ” he said. “The reality is that the threat from Greek contagion becomes a lot less credible.”

The escrow system may also persuade more bondholders to go along with the “voluntary” restructuring. Anyone who did not, hoping that the handful of unexchanged bonds would be paid since the cost would not be that great, would run the risk that Europe would release funds to pay debt service on the new bonds, but not on unexchanged old ones.

There have been Greek rescue packages before, followed by new crises. But this could be different.

By the time it becomes clear that Greece cannot meet its new promises, the recapitalization of major European banks may be completed, and in any case they will have no immediate worry of a Greek default. The European Stability Mechanism, the new European bailout fund, will be in place, and perhaps the International Monetary Fund will have raised more capital. The much-talked-about “firewall” could be a reality, preventing contagion.

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