Greek: Tragedy or Farce?

Currency in Crisis

Moody's may have called the Greek fiscal proposals "relatively well designed" (though it did keep its negative outlook), but the market is voting with its feet and in a big way today with the Greek 2-year note yield jumping 62 bp and the 10-year yield rising 18 bp. The Greek bond market had begun the year on a firmer note after the sell-off into year-end, but in recent days those gains have completely been unwound plus some. Capital is striking after concluding that the present course and the one that Greece has proposed, which means running a huge primary budget surplus, is not very likely to be delivered upon. Some officials have argued that any bailout of Greece would undermine the credibility of the EMU and the euro itself. This seems to be fair for as far it goes. The problem is that it does not go far enough and may reflect the lack of appreciation for what is at stake.

There are some interesting parallels between the US residential mortgage problems and the Greek situation. There was a profound miss-pricing of risk (at one point the Greek premium over Germany was about 30 bp; today 277 bp.) There was some deceit and willingness to suspend judgment. Without much securitization the interconnections are different. While bailing out Greece is problematic, it is misleading to imply that there is a good choice to be made here. There are bound to be unintended and unforeseeable consequences of the failure, at some juncture, to support Greece. Not supporting Greece may engender its own contagion on the periphery of Europe. It may deliver another financial shock to European banks. It may deliver a shock to eastern and central Europe. Moreover, as we learned last year, if European institutions are unwilling to or unable to fill the void, the IMF can. Remember proportions too. The Greek economy is among the smallest in the euro zone, roughly 1/10 the size of Germany. That said, judging from recent comments from some French officials and Eurogroup head Junnker, the euro's pullback here is not undesirable, despite the distasteful conditions which appear to be driving it. (Look for our weekly thematic piece, released Friday, for a more detailed discussion of this topic.)