Mats Persson is Director of Open Europe.
Following a “row” with Germany over the UK’s involvement in a new rescue package for Greece, Cameron has declared something of a victory. The EU bail-out mechanism through which the UK would have been partly liable, the European Financial Stabilisation Mechanism (EFSM), won’t be activated and the UK will only contribute €1bn or so to a fresh Greek aid package via its IMF commitments.
Not that it was much of a row in the first place – it was primarily the Guardian that got a bit over-excited, quoting one German official, which made No 10 look pretty good in the end. A proposal for activating the EFSM was never really on the table. However, since the UK actually doesn’t have a veto over its own participation in this fund (bizarrely, the activation of the EFSM is decided by a majority vote amongst EU leaders) there was still a theoretical risk that the UK could be outvoted. Indeed, the fund could again be called upon in future bail-outs. So this game isn’t exactly over.
But in fact, this is not the most relevant discussion. Yesterday Cameron stated that “when the eurozone suffers, the UK suffers”. In pretty strong language, he has stated that it is very much in the UK’s interest that the eurozone returns to health.
But if this is so, why isn’t the UK participating in a second Greek bail-out? The case seems overwhelming. As the European Central Bank (which itself is heavily exposed to Greece) usefully reminds us, a Greek default “would overshadow Lehman”, while sending every European country, including Britain, back to the stone ages. And as this table illustrates, the UK is already underwriting €14bn worth of loans to struggling euro members, via its EU, IMF and bilateral commitments. Why stop now when the stakes are so high?
Let’s be perfectly clear: the UK is hugely sensitive to any dramatic movements within the eurozone, mostly due to its exposure through the banking system, knock-on effects in financial markets and general economic confidence. But here’s the catch: the bail-outs aren’t working, and a second Greek bail-out could even make things worse in the longer term for both Europe and Britain, without solving any of the root causes. There are several reasons why a Greek bail-out would increase the economic and political costs of this crisis:
First, it’s widely acknowledged that Greece defaulting on its debt isn’t a matter of if, but when – even with the help of a second bail-out – for reasons which are now well documented. The problem is that the first round costs – and probably also the knock on effects – of a default will increase the longer you wait to restructure, as Greece’s debt keeps on building up. Open Europe estimates that a 50% haircut would be needed to get Greece down to a sustainable debt level, around 90% of GDP. By 2014, following a second bailout, the necessary haircut would increase to almost 70%, meaning bigger losses all around.
Secondly, an argument for postponing the inevitable is to allow banks and countries to buffer up against potential losses resulting from a Greek default. But the truth is that banks have had more than enough time to reduce their exposure to Greece. As late as February, Greek bonds were trading at 80% of nominal value (meaning that investors could have walked away with only a 20% loss on their Greek bonds). This is a pretty decent recovery rate given the utter mess that Greece is in. Why did the banks not take this deal? A number of reasons for sure, but one is that they are continuing to expect that, given the enormous stakes, politicians and the ECB will continue to bail out Greece. This fuelling, not ending, Europe’s debt bubble (while taking moral hazard to a whole new level).
Thirdly, and the most important political point. We estimate that the EU, IMF and ECB accounted for 26% of Greek debt at the start of this year; by 2014, following a second Greek bailout, this will have risen to 64%. In other words, in a few years' time, roughly two-thirds of Greek debt will be taxpayer-owned (though UK taxpayers will not be liable for much of this). Taxpayers in the eurozone will therefore be left with most of the bill from a likely Greek default, while private investors are left off the hook. This simply isn’t right.
In other words, Cameron is correct that the UK has a huge stake in all of this. But as 14 MPs from the new intake rightly argued in a letter to yesterday’s FT (£), more bail-outs will leave the UK equally exposed to future meltdowns in the eurozone – possibly on an even larger scale. Instead the UK should be pushing EU leaders to plan for an orderly restructuring of Greece’s debt (combined with a limited cash injection) which will actually deal with Greece’s debt burden (and yes, even so, the eurozone will have to make a choice at some point whether to put Greece and possibly others on permanent life support or downsize the eurozone). This will serve the UK’s interest far more than any of the proposals on the table.