Is There Any Hope for Greece;

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Barry Eichengreen is a professor of economics at University of California, Berkeley. He is the author, most recently, of "Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System."

Plan A for Greece – lowering wages, benefits and other costs but ... without reducing the nominal value of the debt – is clearly not working. It is economically perverse, since the debt only becomes heavier as the economy shrinks. And it is politically perverse, since asking everyone else to take painful cuts while sparing the bondholders violates basic principles of equity.


But abandoning the euro, a popular if naïve alternative, will hurt Greece more than it helps. The country’s debt to the International Monetary Fund, the European Union and foreign commercial banks will still be denominated in euros, and that burden will only grow more crushing as the "new drachma" depreciates against the single currency. News that Greece was reintroducing the drachma would cause the mother of all bank runs. The country would have to close down its financial system and physical borders.

In addition, the commitment of other members to the euro would be called into question. Greece’s E.U. partners will therefore go to very considerable lengths to prevent this from happening.

By process of elimination, the only solution is internal devaluation with debt restructuring. E.U. leaders are being dragged, despite themselves, to this realization. Much of their kicking and screaming is over the consequences of triggering credit default swaps on Greek government bonds. European policymakers know roughly how many credit default swaps are outstanding but not which financial institutions stand to take A.I.G.-sized losses if they are activated.

The imperative therefore is to reduce the value of Greece’s debt without triggering a default event. One way of doing this is for the European Financial Stability Facility, the E.U.’s new bailout fund, to buy the government’s bonds on the secondary market, giving the holders its own bonds in exchange. Since Greece’s bonds currently trade for only a fraction of their face value, a little bit of E.F.S.F. money would go a long way.

If the Greek government commits to servicing the new bonds first – if the new bonds are "senior" – they will be attractive to investors. The E.F.S.F. can expect to earn back what it invests. Seniority also means that E.F.S.F. purchases will not drive up the prices of remaining Greek government bonds, diluting the effectiveness of the operation, as the Italian economist Angelo Baglioni has explained.

As the price for its help, the E.U. will undoubtedly demand a commitment to early and comprehensive privatization. But dumping the Greek government’s property onto the market would be inefficient and unfair. Forcing the government to liquidate its assets at fire-sale prices would depress the revenue it takes in. This would also be seen as squandering the national patrimony. It wouldn’t fly politically.

The solution is for the Greek government to retain warrants on these newly privatized assets. Ask Greece to do the privatization now, in other words, as a way of locking in reform. But require the buyers to give the government additional payments once the economy starts doing better and the value of those assets recovers.
www.nytimes.com/roomfordebate/2011/05/23/is-there-any-hope-for-greeces-debt-problem/going-beyond-austerity-measures