Although markets have been kind to Italy and Spain recently, most economists agree the crisis is far from over.
Greek politicians are still trying to hammer out a deal without jeopardizing their popular support, economy, and bailout funds. Yet troika officials are still vehemently supporting austerity, regardless of signs that more spending cuts are unsustainable.
And despite tentative agreement to move up implementation of a new, permanent eurozone bailout fund and institute a fiscal compact, rough waters are still ahead for the crisis effort.
We’ve compiled a list of all the issues still threatening to derail the monetary union. Read and weep, folks.
Private sector involvement in Greece.
Since this crisis seems to be exacerbated by a lack of market confidence, EU leaders need to act in a way that will restore faith in sovereign borrowing. Doing this is difficult when EU leaders also want creditors to take 70% haircuts on their holdings of Greek debt (since it turned out to be a poor investment choice).
EU leaders want Greece’s creditors to participate voluntarily so as to avoid provoking a credit event, which would result in payouts of credit default swaps—insurance contracts on purchases of sovereign debt. However, there’s little chance they’ll get a sufficient number of bondholders to go all in.
If EU leaders pull a high-handed maneuver to to avoid a credit event, then this would undermine the entire CDS industry and make it incredibly difficult for financial institutions to make a certain hedge against sovereign debt. On the other hand, the effects of a credit event are uncertain—Citi’s Willem Buiter estimated late last year that exposure to contagion would be minimal ($74bn gross, less than $4bn net) in the event of CDS payouts, but the problem is that no one really knows.
Official sector participation in the Greek debt restructuring.
The most recent terms of the deal between Greece’s creditors and its government reportedly hinge on whether or not the European Central Bank will take cuts as part of the debt restructuring. The ECB holds €50 billion ($65.7 billion) in Greek bonds that it bought at a discounted €38 billion ($49.9 billion)—a full 15% of the country’s debt obligations.
Involvement of the ECB in the bailout would assure investors that European leaders are willing to do what’s necessary in order to save the euro, even if it involves essentially monetizing debt.
Greece’s massive debts.
Even with the prospect of huge haircuts for the private sector, there is little hope that the country will be able to return to the markets for funding in the foreseeable future. In fact, Greece will probably have difficulty bringing its public debt-to-GDP ratio under 120% for the next decade or so.
Drastic austerity measures have taken an axe to growth and have caused massive strikes and riots in Athens. Now EU leaders want Greece to impose a new round of still deeper spending cuts, and Germany has even threatened a proposal that would take away the Greek government’s power to control the budget and place it in an EU budget commissioner.
- Here’s Who Gets Clobbered If Greece Defaults
- CITI’S BUITER: There’s A 50% Chance Of A Greek Exit From The Eurozone And Here’s How It Would Happen
- This Is The Realistic ‘Best Case Scenario’ For Europe