I’m not sure the Greeks have a full understanding of their financial situation, and as an outsider looking in it’s even more opaque. The Greek quagmire began years ago during a period of great prosperity; the seemingly endless summer enticed them to run up larger than allowed deficits and engage in otherwise unorthodox financing methods (they are orthodox tools, just not for a government) and the Greeks were able to mask the true state of their countries balance sheet.
When kept in context of the EU, Greece is no powerhouse and their debt is small compared to Spain, Italy, France or Germany. However, an EU law prohibits one sovereign country from assisting another sovereign country that uses the euro. Therefore a direct bailout seems less likely and would indicate a somewhat desperate situation in the EU. Desperate for two reasons: it would certainly indicate Greek implosion (and the accompanying moral hazard) and the northern European banks that have purchased Greek paper are not stable enough to sustain losses.
Greece has been given until mid March to prove their financial house is in order and will remain on track.
Greek implosion is remote because of the significant impact implosion would have on the euro and fallout effects on member countries. This amount of time also allows other EU countries and the IMF to quantify and qualify the situation, determine the amount of the bailout and the real cost if one isn’t enacted.
There are very real doubts that Greece has any industry that can provide a sufficient amount of goods or services to bring much needed revenue to the country especially during a global recession. If a bailout is provided then it certainly provokes Portugal, Spain, Ireland and Italy into running up larger deficits and then expecting assistance since they are also running high outstanding debt to GDP ratios.
Think of this as a moral hazard flu.
The other option is to allow Greece to go under without EU support and try to put out a lot of little fires as one bank after another is forced to write down Greek debt (Dubai paper is being sold at ~60 cents on the dollar, or 40% haircut). Northern European banks have much higher leverage ratios and assets on their books relative to the host countries GDP, which creates a large skew.
According to their last report Deutsche bank is leveraged 50:1 and holds 1.5 trillion in assets (2009) but Germany as a country only produces 2.9 trillion per year! JP Morgan Chase only holds 1.5 trillion, has a leverage ratio of about 10:1 and the US has a GDP of 14.2 trillion. A bond haircut for European banks holding Greek paper would result in a period of forced de-leveraging or higher leverage ratios with a financial system that is less stable than before and could be a drag on any growth going forward since Northern European banks wouldn’t be able to participate.
Greece can either stay in the frying pan or move to the fire; it’s not within the best interest of other EU countries to act first. This highlights a turning point for the euro as a currency as there were never provisions made for fat tail scenarios (like the past two years). Certainly hands will be wrung and teeth gnashed, provisions put in place and compromises made but will any of this be enough to restore lost confidence if the EU countries were to deviate from their charter?
Adam Smith’s invisible hand will force answers one way or another and the Greeks have until March 16th to push back.