Friday, 4 November 2011

Democracy and the Euro-Greek Tragicomedy

It appears that Aristotle defined tragicomedy as a serious action with a happy ending. So can we write the recent tragedy of the Greek bailout and the ongoing comic infighting of the Greek politicians as a prelude to a plot with a happy ending?

Last night’s refusal to agree on a Greek government of national salvation might lead to either new elections or a referendum on the bailout program. This should be the democratic way to solve the current deadlock. The people should be given the last word; even if the results leave the nation divided in two almost identical camps the winning camp has the mandate to carry out his policies. That is the foundation of democracy and it is preferable to forcing the Greeks to accept the undemocratic tutelage of the shameful duo Merkel-Sarkozy.

Now, let’s imagine that the camp opposing the current bailout wins and decides to declare a unilateral default on the Icelandic-style, but decides to keep the Euro. This is the scenario feared by the “very serious people in pin stripes” and some economists who fear the contagion of a disorderly bail-out.

What can Mr. Juncker, Draghi and Barroso do about it? According to Mr. Barroso the Lisbon Treaty does not have any legal mechanism to expel a Euro-zone member. Mr. Draghi’s interpretation of the European Central Bank remit is that it does not include any responsibility as lender of last resort for any member country. Mr. Junker’s Eurogroup meeting of the Finance Ministers of the Eurozone countries was institutionalized by the Lisbon treaty without any power over its members. So, let us image also that they decide to do nothing.

Would this mean the end of the Eurozone? In principle no! For instance, in the Dollarzone (USA) when a local government defaults on its Muni-bonds the Federal Bonds barely move. Yes, I know, the USA has a Federal budget. However, its interstate transfers are not enough to justify the decoupling between the Munis and the Treasuries. What is different is that the FED (the US central bank) has an implicit remit to bailout the major banks whose failure would represent a systemic risk as it has shown in the crisis of 2008.

This is a key weakness of the current ECB thinking. Should the markets attack the other highly leveraged countries to an extent that would bankrupt some of their major banks in those countries the ECB might feel restrained in continuing to lend to such countries.

Indeed, as illustrated by its continuing purchase of low quality securities, the ECB does not need to have an explicit lender of last resort mandate enshrined in the European Union treaty. Nor does it need to take massive losses on its ABS holdings, as has been propagated by the German Press. For instance, it can simply print money to finance an off-balance sheet vehicle to park such securities and ask the EFSF and the Governments rescued to share on its capitalization.

So here is a script for a happy ending to the Greek tragicomedy:
1) Greece reasserts its firm commitment to remain in the Euro;
2) Greece defaults on its debts and goes to the London and Paris clubs for a restructuring deal with better terms than those currently on offer;
3) To support the debt restructuring program Greece applies to the IMF for a new extended facility;
4) Meanwhile the ECB extends an unlimited liquidity line to one or two of the best Greek banks to keep the financial system afloat, subject to Greece agreeing to points 1-3;
5) The ECB announces that it will provide such lines to any other member who needs them;
6) To kill any doubts about its own strength the ECB will begin selling its low quality assets to special purpose vehicles;
7) Faced with such determination the markets will begin pricing the sovereign debt spreads of the various Eurozone members in accordance with their respective risk profile; and
8) After the successful implementation of programs 2 and 3, Greece regains market access within three years.

Here is the lesson from such tragicomedy. One should never give up on the ability of democracy to find a solution. It may be convoluted; it may take some time, but it will be better than a dictatorial solution under a veil of technocracy or to a shameful begging for help from a mixed bag of world leaders gathering in the G20 group.

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