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Greece is not sustainable without a continual influx of subsidized capital, the Greek systems will crash simply under the weight of its sovereign debt, and that’s assuming that the banks don’t crash it first.The choice for the rest of Europe is an unenviable one.
Either subsidise Greece and any other countries who can’t meet their bills in perpetuity or eject them from the eurozone.
However, Greece is not an island and ejecting them would cause cascading bank failures in Spain, Italy, France and the rest of the eurozone in a matter of a few weeks, so before you can seriously discuss ejecting Greece from the eurozone, you first have to build a structure that can contain the damage.
Step one is to ratify an agreement called the EFSF2 that is already under discussion in most European Parliaments.
The original EFSF, the European Financial Stability Facility, was designed to serve as the bailout regiment — it is in place.
The reforms, part two if you will, were designed to broaden its scope and allow it to deal with, for example, banking crises and make the bailouts more sustainable in the long run.
This program is currently being debated in all of the European capitals right now, pending ratification.
EFSF2 faces two major challenges. The first is from a series of states led by Finland and the Netherlands who are seeking collateral deals. Now, in the end, STRATFOR sees these collateral deals being allowed and struck probably by the end of the month, certainly by the end of the quarter. That’s not where we see the major problem. The major problem is that Germany, the country who wrote the EFSF protocols, won’t ratify it themselves. The EFSF protocols in specific are not very popular with German voters, particularly among the conservative parties that form the current government. It is possible, although not particularly likely, that the German parliament may reject the very reforms proposed and written by the German government. The final vote will be at the end of September.
That’s step one. Step two is to expand the bailout facility so that it can handle additional problems. Currently, the EFSF has the authority to raise 440 billion euros backed up by various state guarantees. That might be sufficient for a Greece or an island, but it’s woefully insufficient for the scope of the problems ahead. Those problems are twofold. First, you have Italy with 1.9 trillion euro in outstanding government debt. If Greece falls or is ejected, it’s highly likely that the Italians are going to be following suit. The EFSF strategy to date has been to provide a bailout package to damaged states in a volume equal to their total financing needs for a three-year period. In the case of Italy, you’re talking about 700-800 billion euro.
Additionally, one must assume that if Greece is ejected from the eurozone, that it will default in short order on its debt, causing the banking crisis cascade of failures that was mentioned before. This will require, at a minimum, about 400 billion euro to stop cold any Greek-specific contagion — that’s about the outstanding value of Greek government debt. It will also require a cushion of funds to counter the inevitable market chaos that will happen once Greece defaults. Using the American 2008 financial crisis as a template you’re looking at needing a fund of about 800 billion euros to backstop all the European banks that are exposed to distressed government debt. Add that together and you get a ballpark figure of about 2 trillion euros of bailout funds needed. STRATFOR expects the expansion of the EFSF to be the issue of 2012 in Europe. Without a bailout facility of that size, it would be impossible to head off the Italian catastrophe or a major European banking crisis, either of which could easily lead to the dissolution of the eurozone.
Now obviously there is any number of ways that this could all go horribly wrong. For example, a number of states, most notably including Germany, could decide that the cost of the bailout program is simply too high and vote it down, triggering a complete collapse of the system right off the bat. Greek authorities could come to the conclusion that they’re about to be jettisoned anyway and preemptively default, taking the entire system with them before the EFSF is ready to handle the collateral damage. An unexpected government failure could lead to a debt meltdown somewhere else. Right now Italy and Belgium are the two leading candidates. Already the Italian prime minister is scheduling meetings with senior European personnel to avoid having to meet with Italian prosecutors. And Belgium, which hasn’t had a government for 17 months and whose caretaker prime minister announced that he was going to quit today.
Finally the European banking system might actually be in worse shape than it looks like and 800 billion euro might not cut it. After all, major French banks were all downgraded just today, but shy of allowing every capital poor state in Europe to go on the doll permanently — this is the only road forward that can salvage the eurozone.
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