Bill Emmott - International Author & Adviser


A new Lehman looms. Its name is Greece
The Times - February 20th 2012

There is something spooky about the economic and financial scene on both sides of the Atlantic, something all too reminiscent of the summer of 2008.  Then, as now, the many warnings of impending doom did not seem to tie in to reality. Things were not great, but we had withstood the demise of Northern Rock, Bear Stearns and a few other banks without too much china being broken. Stockmarkets were holding their nerve. So when Lehman Brothers turned up with a begging bowl, the US Treasury chose to make an example of it, pour encourager les autres.

            The results of that decision, taken less than four years ago, sit there for all to see in the unemployment rolls and hugely expanded public debts in both Europe and America. Which is why it is rather surprising, indeed spooky, to see Germany treating Greece in pretty much the same way as Hank Paulson’s Treasury dealt with the Lehman investment bank.

            After all, perhaps the Germans are saying to themselves, things in Europe are a bit grim—this year the eurozone will be in recession—but they are not really disastrous. Only in Greece itself have strikes and street protests become daily occurrences. Spain has a new austerity-oriented government, and Italy has the wonderful Mario Monti. The other super-Mario, President Draghi of the European Central Bank, has averted a funding crisis for European banks by lending them truckloads of money.

            Stockmarkets are behaving as if a new dawn has broken. In America, where admittedly unemployment has been falling and the economic data has been cheerier than in Europe, the S&P 500 index is at its highest level since mid 2008, and has risen by 11% since last October. In Britain the FT-SE 100 is up more than 8% since October, as is the FT-SE Eurofirst 300, which tracks European shares.

            People have been talking about an impending Greek default for about two years now, and it hasn’t happened. Yes, the Greek economy is imploding, with its GDP falling by 7% last year and perhaps 4% or more this year, but these are falls from numbers that were as artificial as were bankers’ profits from derivatives holdings and sub-prime mortgages.

            Yes, buildings burn and opposition politicians mumble about renegotiating rescue deals after they win the general election in April, but they soon back down. So some dangerous complacency is creeping in. It will always be alright on the night, runs the thinking, once the fires have been put out. Greece can be pushed and kicked and bullied into good behaviour.

            The brinkmanship game is being played on both sides, with the Greek government using fears of default to wring a deal out of private bondholders and some favourable treatment by the European Central Bank of its own holdings of Greek debt, but most of all the Germans and other northern creditors are using it to force the Greeks into tougher reforms.

            On the face of it, this makes sense. Greece does need outside pressure to force it to carry out controversial privatizations, and cuts to minimum wage levels and pensions. Northern European voters, suspicious that good money is being thrown after bad, need to be convinced that yet another huge bail-out package, this time worth 130 billion euros, is not just going to be used to let tax evaders off the hook.

            But behind that face lies the Lehman danger, with a nasty twist. The pressure on Greece is indeed encouraging les autres, but not by enough to make the consequences of a sudden Greek default something to shrug off. The direct impact of Greece declaring a moratorium on all its private and official obligations might be manageable, but it is extremely unlikely that financial markets will then assume that Portugal, Ireland, Spain and Italy are so different from Greece that the risks of holding their debt would be unchanged, nor that the European banks that suffer losses on Greek debt will assume their lending to the other southerners remains safe.

            There will, in other words, still be a lot of contagion, of an unpredictable sort, just as there was when Lehman went down. The nasty twist is that this risk is not going to go away, even if each round of the brinkmanship game goes well. Greece’s public debt, even if the bail-out package goes ahead and private lenders accept the losses they are being offered, is still variously forecast as being between 120-130% of GDP in 2020, and those figures depend on an economic recovery.

            Meanwhile, the other southern European debtors’ situation is not going to improve quickly. Austerity programmes look sure to lengthen and deepen their recessions, so deeper recessions may well send their debt totals rising rather than falling.

            There is no easy way out of this. But the Lehman experience surely teaches us that hoping for the best is not a good approach. The right way to deal with Greece remains what it has been throughout this long, tragic drama. For its own sake, but even more so for that of the other 16 eurozone members, it needs to leave the euro and default on its debts, but with financial support from its neighbours as it does so.

            A managed default and exit from the currency would be the best way to avoid catastrophic contagion of the Lehman sort. There would still be some contagion, but with a clear plan, an aid package from Europe and more emergency funding for European banks from the ECB, it could be contained. If Greece looked likely, within the next decade or so, to actually meet the criteria of the eurozone’s fiscal pact, this could be avoidable. But it just doesn’t.

            The euro would be changed forever by a Greek exit. Adoption of the currency would no longer be an irrevocable act. Membership would become contingent on performance and behaviour, and speculation would always be present about who might leave next. Yet isn’t that what the Germans really want? The discipline of rules about deficits and debts needs to be reinforced by the discipline of financial markets.

            The original design of the currency, in the 1992 Maastricht Treaty and then its launch in 1999, relied on the principle that no country could be bailed out, and that sovereign borrowing would be constrained by market perceptions of members’ credit-worthiness. Unless Germany is willing to move to collective responsibility for debts, that market discipline is always going to be vital. A Greek exit would reinforce it. A managed Greek exit would reduce the danger of another Lehman shock. Currently, that danger is being under-rated.


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