What The European Union Decision on Greece Really Means

The leaders of the European Union worked through the night last night to come up with a plan to save Greece, the Euro as a currency and the banks that will take the hit to their capital required to achieve these goals.

What did the EU decide? Here are the main points from their communique:

“All Member States of the euro area are fully determined to continue their policy of fiscal consolidation and structural reforms. A particular effort will be required of those Member States who are experiencing tensions in sovereign debt markets.

“We commend Italy’s commitment to achieve a balanced budget by 2013 and a structural budget surplus in 2014, bringing about a reduction in gross government debt to 113% of GDP in 2014, as well as the foreseen introduction of a balanced budget rule in the constitution by mid 2012.

“We reiterate our determination to continue providing support to all countries under programmes until they have regained market access, provided they fully implement those programmes.

“To this end we invite Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount of 50% on notional Greek debt held by private investors. The Euro zone Member States would contribute to the PSI package up to 30 billion Euro. On that basis, the official sector stands ready to provide additional programme financing of up to 100 billion euro until 2014, including the required recapitalisation of Greek banks.

“Being part of a monetary union has far reaching implications and implies a much closer coordination and surveillance to ensure stability and sustainability of the whole area. The current crisis shows the need to address this much more effectively. Therefore, while strengthening our crisis tools within the euro area, we will make further progress in integrating economic and fiscal policies by reinforcing coordination, surveillance and discipline. We will develop the necessary policies to support the functioning of the single currency area.

“The European Financial Stability Facility will have the flexibility to use these two options simultaneously, deploying them depending on the specific objective pursued and on market circumstances. The leverage effect of each option will vary, depending on their specific features and market conditions, but could be up to four or five.

“Financing of capital increase: Banks should first use private sources of capital, including through restructuring and conversion of debt to equity instruments. Banks should be subject to constraints regarding the distribution of dividends and bonus payments until the target has been attained. If necessary, national governments should provide support, and if this support is not available, recapitalization should be funded via a loan from the EFSF in the case of Eurozone countries.”

Those are the words. But, what does it really mean?

First, Europe has agreed to an extended period of austerity, including national budget reductions, layoffs of public employees, increases in minimum ages required to participate in publicly paid retirement systems, and selling off public assets such as buildings and infrastructure to put money in public treasuries. The problem with most of these ideas is that they assume a growing economy and GNP. This seems to be beginning slowly in the United States but Europe is in a zero growth situation in which public spending cutbacks will only make their economies shrink more. It’s a vicious circle - more public cutbacks and less private income and growth to make up the difference, or to provide the taxes needed to pay for anything, because Greece, Italy and Spain are flat broke. The EU has proof that this approach will not work - in Greece - but it appears ready to try, try again.

Second, the European Central Bank has agreed to use its power to deliver lending facilities to the debtor Eurozone nations, but only if there is no other choice. So, we will undoubtedly see more of the messy debt bailouts like we witnessed with the Greek situation - the EU will dither and talk until the last minute, destabilizing markets and currencies in the process, before it acts to solve each problem.

Third, Germany has won, insisting that its public treasury will not be used to bailout debtor nations.  Instead, Germany Chancellor Merkel has pushed through a deal in which private banks will negotiate with Greece (and any other Eurozone nation that can no longer borrow to pay for its governmental needs). The private banks have been told by Merkel and her parliament, by means of last night’s EU decision, that they can expect to take ½ Euro in repayments for every 1 Euro lent. So, the private banks who bought Greek bonds will take what the Europeans are calling a haircut on the $120B Greek debt they own. To rebuild their capital accounts, to cover their losses in Greek debt and surely to prepare for further “haircuts” when other Eurozone debtor nations decide that if Greece can play that game, they can, too - why not let private banks pay for the incompetent management of their economies instead of having to do it themselves??

So, the recapitalization of banks will provide a buffer for the next public sovereign debt crisis, but it will come at the expense of taking money out of the overall European economy to put it into bank capital accounts. This will be another damper on Europe’s ability to get itself moving in a positive economic direction again. Remember Lehman and its consequences for the broader American economy? That’s what we may eventually be looking at in Europe.

And, finally, there was no mention of the Euro itself, except to say that it has been saved, and these words came from analysts, not those engaged in the decision-making itself. But, until the Euro is restructured to separate industrial nations from agricultural or service industry nations -  and until these various types of nations can vary their public debt load without violating Eurozone rules set up and agreed to in the Maastricht Treaty - Europe is not going to be either stable or an economic growth region.

As James Carville said to Bill Clinton about the economy, “It’s the Euro, Stupid.”