The owner of a fast food franchise, the Euro Club, asks his profligate younger brother run a new store downtown. A decade later, the younger brother has run the shop's finances into the ground. He gets some extra cash. But after one year, he's still bleeding money. He begs his older brother for another loan. Should the older brother:
(a) Loan him more money from his employees' compensation pool? (b) Assume some of the losses, downsize the younger brother's store, and take an even bigger financial hit? (c) Shut down the store and take a ginormous financial/PR whopper now rather than later?
This isn't a perfect metaphor for the Greek debt crisis, but it's useful. The EU's single monetary policy required a unison of fiscal responsibility among its member states. That means 2001 entrant Greece, the profligate younger brother of Europe, never stood a chance. Facing financial ruin in 2010, Greece begged for cash. The IMF and EU lent Athens 110 billion euros. Greece burned through it. One year later, the country is still facing ruin and still begging for cash. For the EU's central powers, Germany and France, there's no good way out of this:
(a) If the EU puts more money on the line with another Greek loan, taxpayers will revolt. (b) If Greece restructures its debt and pays its lenders 50 cents on the dollar, French and German banks with Greek loans on their books take a hit like they haven't seen since Lehman failed. (c) If Greece drops the euro to restructure on its own currency ... well, all hell breaks loose on the continent.
The most likely scenario today is (a): Another loan for Greece. Germany and France, who have to demonstrate they're serious about getting back their money, have reportedly asked Greece to sell government property to pay back lenders. One rumor even has European powers asking to administer the Greek tax department to ensure enough revenue is raised to pay back Europe's banks.
"Europe's political elites don't trust the Greeks, and they want to ensure their electorates that the money will be repaid," says Desmond Lachman, a resident fellow at the American Enterprise Institute who has worked for the IMF and served as the chief emerging market economic strategist at Salomon Smith Barney. "Europe is willing to put taxpayer money at risk because a default could trigger a banking crisis in the corps of Europe" that one ECB official warned could be "worse than Lehman."
A dramatic Greek default (that is, an acknowledgement that Greece has broken promises to pay back its lenders in full) could trigger higher interest rates in Ireland and Portugal. If more countries join Greece on the help list, that would raise the overall price of bailing out the periphery of Europe.
The end game, Lachman says, is that Greece has to leave the eurozone. This is the prediction he made in January 2010, and it's the prediction he makes today in the Financial Times.
"Even if you do a big debt restructuring, you're not done," he tells me. "Restructuring gets you halfway there, but you still need a cheaper currency," which would make exports more attractive and allow Greece's products to become internationally competitive.
In short, European elites want another bailout on harsher terms, but Greece is asking for more funding on easy terms. "Something is going to give and when it does, you're going to see a huge amount of political discontent somewhere," Lachman says. "Riots in Greece if Germany gets its way, or a tea party revolt in Germany if Greece gets easy money. This is a monumental mess."