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Why has the Greek crisis not been solved? - Outside View by Asad Dossani

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Why has the Greek crisis not been solved?
Jun 27, 2011

Global equity markets have been rattled in the last couple of weeks as the Greek crisis continues to make headlines. Just over a year ago, in April 2010, Greece received its first bailout, amounting to EUR 45 billion, as they needed the money to rollover their debts, or they would have defaulted. A month later, in May 2010, they accepted an additional EUR 110 billion, as the first bailout was not enough.

Now Greece needs more money to continue to rollover its debts. European officials are demanding further austerity measures in exchange for additional bailout funds. They maintain their stance that a Greek default would be catastrophic and so the bailouts and austerity measures are necessary. Likewise, the Greek prime minister has the same stance. It appears as though government officials in Europe and in Greece will go to any lengths to avoid a default.

So why does Greece continue to need more money? Were the first bailouts not large enough? Will this next bailout solve the Greek crisis? The unfortunate answer is that further bailouts will not solve the problem. The first bailouts didn't solve the problem, and the problem would not have been solved even if those bailouts were larger.

The answer to this is actually quite straightforward. Greece does not need a bailout, it never needed one, and additional bailouts will only make things worse. What Greece needs is to default. Let's go through why this is the case. A bailout is a loan provided that gets repaid with interest. It adds to a country's total debt. A country should use a bailout if they are illiquid but still solvent - meaning that they temporarily need cash, but their finances are fundamentally strong. This ensures that they can repay their debts when the time comes.

However, when a country is insolvent (like Greece is), bailouts don't help. An insolvent country has debt levels that are unsustainably high. A bailout just increases this debt level and delays the inevitable default. What Greece needs is a reduction in their debt to a more sustainable level. This can be achieved through an orderly default, where creditors agree to restructure the debt.

The restructuring should include reduction in the face value of the debt, reductions in the interest rate, and extensions in debt maturity. Once default occurs, their debt level will be sustainable and their economy can grow again, free of these constraints.

A restructuring is in everyone's best interest. It's good for Greece because it will increase economic growth. It's good for other European countries because they will no longer need to continue bailing out Greece. As far as Greek bondholders are concerned, it's good for them too. If they agree to restructure, they will at least get a significant portion of their money back. If they don't do this, they will end up getting even less money back, as default is inevitable given that Greece is insolvent.

Disclosure: I do not hold the commodity/currency held in this article.

Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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