Even if the Greeks abide by their agreements and all of the still-vague elements of this recent plan work out as well as the French, Germans and other nations of the European Union (EU) hope, the problem goes far beyond Greece. The situation will ultimately demand additional financial resources that only the European Central Bank (ECB) can provide. And even if the ECB steps up, Europe must also address the underlying imbalances in the common currency that so contributed to today's financial tensions. Without action on this basic issue, problems will only recur, even if this latest remedies work out better than anyone expects.
This latest European plan is complex. Private lenders, mostly European banks, have agreed to write down their Greek debt to 50% of its face value. Although some 40% of Greece's 350 billion euros in public debt is held by the International Monetary Fund (IMF), which refuses to accept any losses, the writedown on the remaining 210 billion euros in private hands will bring Greece's outstanding public debt down to an estimated 120% of that country's gross domestic product (GDP) by 2020. Furthermore, the agreement should enable Greece to borrow an additional 30 billion euros for needed financing from what is presumably Europe's newly enlarged bailout fund, known as the European Financial Stability Facility (EFSF).
Plans also aim to guard against a spreading contagion of fear by levering up the existing 440 billion euros in the EFSF to some 1.0 trillion euros. Since some 150 billion euros in the original fund has already gone to Greece, Ireland and Portugal, the remaining balance will have to lever up four times or more to reach the 1 trillion euros goal.
It is not apparent from where all the additional funds will come. Negotiators have spoken of China and Brazil. Though it may seem dubious that China and other nations would buy into the fund, it would at least give them a way to support European and therefore global markets with a general European credit instead of more questionable Greek, Spanish, or Italian credits. Greece has also pledged 15 billion euros for the fund on top of the 50 billion euros it already plans to raise from privatizations. But since Greece is already falling short on the original privatization plan, it is not apparent that it will make the contribution. It is a small part of the picture anyway.
This enlarged EFSF would support markets in three ways. One, it could buy the debt of distressed countries directly in secondary markets, as the European Central Bank (ECB) has done separately. Second, the facility could guarantee a buyer's initial losses up to, say, 20%. Though this would only provide a partial guarantee, such help presumably would permit the periphery to borrow at a lower net cost than otherwise. Third, the facility may play a part in recapitalizing Europe's banks. The plan calls for the banks to raise an additional 100 billion euros or more of Tier 1 capital by June 2012. Though most of the banks say that they can meet the goal by retaining earnings, the European negotiators have spoken about the EFSF guaranteeing medium-and long-term bank debt and of nations borrowing from the fund to help their domestic banks raise the needed capital.
Clearly, Europe's solution remains vague. Even so, it has value on two counts. First, it shows a renewed commitment from the Eurozone nations to overcome their national differences and create a European solution. Second, by relieving the most immediate pressure surrounding Greek debt and default, it buys time to improve arrangements and find other sources of relief. Key to this next step is the European Central Bank.
The ECB is essential because the problem is so much bigger than Greece. Actually, if Greece were all there was, the EU could manage matters easily. Total Greek public debt amounts only to a small 1.1% of the 31.7 trillion euros in assets held by euro area financial institutions. But Ireland is still running budget deficits even greater than Greece, in excess of 10% of GDP, in fact, and carries an outstanding debt burden of over 100% of GDP. Portugal projects deficits at over 6% of GDP and also reports an outstanding debt overhang at over 100% of GDP. Though Italy has deficits of only about 4% of GDP, its outstanding public debt approaches 120% of its GDP.
Similar problems are evident in Spain and Belgium. Rating agencies have downgraded many of these countries and put others on watch lists, while markets already have bid up rates on the debt of all these nations, squeezing their finances still more severely.