Greece, Ireland, Portugal and the European Central Bank's Problem

To put the European Union fiscal problem into perspective, vis-à-vis Greece, Ireland and Portugal, let’s imagine that these 3 countries are households.

- They own their home, with a mortgage at a 3.5% interest rate (the average rate for European countries when they sell their government bonds).

- Lately, the parents have been having payment problems - they pay the mortgage each month, but are complaining that the old bank that holds their mortgage (i.e, international investors that buy the government bonds) has raised their interest rate because it has lost confidence that the parents will continue making their monthly payments.

- So, the parents look around for another bank so they can transfer their mortgage at the old rate. They find a new bank (the European Central Bank - ECB), but instead of offering a lower rate, the new bank says, we want 7% interest because we know your household is having problems.  

- The parents think it over, but the old bank hears about their problems and the offer made by the new bank. Soon, the old bank says to the parents, we now want 9% interest to continue to hold your mortgage, because we are taking a big risk to continue with you as a customer.

- The parents, backs to the wall, take the new bank’s offer but the new bank adds other controls (the children have to walk the 12 miles to school instead of paying to take the bus, the parents can serve dinner only 3 times each week, the house has to be repaired without the new bank giving any more money to pay for the repairs, and the mortgage must now be paid off in half the time allowed under the old mortgage).

- In several months, the children revolt because by the time they walk to school the morning classes are half over. The parents revolt because with only 3 dinners a week they and the children are weak and hungry.

- They say to the new bank, we are not going to accept your controls or the 7% interest rate any longer because it is killing us.

- The new bank, not wanting to foreclose, says, okay, we’ll re-finance at a longer payment period , but you have to continue to accept the 7% interest and controls.

- The parents agree, but after a few months under the new regime, they realize that if they simply stop paying the new bank, not much will happen, and they are sure, because they have had other banks approach them with offers, that there are better deals available if they just default on the new bank’s mortgage.

- The parents default, and the new bank loses the money it lent and has no recourse to recover it, or the house.

That is the European Central Bank’s position today - with Greece, which is already threatening to default, and with Ireland or Portugal which know that other banks might help but are waiting because they are sure that finally Ireland or Portugal will default, too.  

That is why the European Union, and Germany in particular, are very worried. If these countries default, the value of the Euro will tumble unless the other European Union countries come up with massive capital injections to cover the ECB’s losses.

And, my friends, the countries of the EU do not have a lot of cash to throw around right now, with the exception of Germany.

You can write the end of the story yourself.