February 14, 2015
Buried on the back pages of the business sections of leading newspapers is a high stakes poker game that will soon migrate to the front page – an attempt by the newly-elected Greek government to renegotiate the terms of its recent bail out.
Greece is a member of the European Union; a collection of European countries that banded together recently, scraped their national currencies, and formed a common currency called the Euro. The problem with such an arrangement was that member countries could borrow money from the European Union in the form of bonds. The value of these bonds varies to some extent with the perceived probability they will maintain interest payments and whether to full value will be remunerated on their due date.
In the summer of 2010 several countries, Portugal, Italy, Ireland, Greece and Spain, had difficulty maintaining the interest payments on their respective bonds. This led to a financial crisis and credit crunch that culminated in a grand agreement whereby the European Central Bank, European Union and IMF (International Monetary Fund) promised to back their bonds as long as these countries agreed to austerity measures that meant higher taxes and fewer social services.
So far, Portugal, Spain, Italy and Ireland have managed to muddle along, but not Greece. The decrease in social services, higher taxes and increasing unemployment resulted in Greece recently electing Alexis Tsipras of the leftist Syriza Party as their Prime Minister. Tsipras has promised to renegotiate the 241 billion Euro debt (around $280 Billion) and has already ended some of the most unpopular austerity measures such as high property taxes and public sector layoffs. He also is threatening to default on the bond payments unless the debt can be restructured. The European Union has responded by saying they can default and leave the Union if they wish. If this happens, a significant number of Greeks will lose a large portion of their life savings, as their money is denominated in Euros. The leaders of the European Union believe Tsipras will never allow this.
Who will blink first? My bet is the European Union. Tsipras is playing a very strong hand. Tsipras has the good fortune of having a finance minister, Yanis Varoufakis, who not only is a respected economist, but an expert in game theory.
Varoufakis knows that if there is a threat of a Greek default, there is a possibility the contagion will spread to other European bonds resulting in Wall Street banks and brokerage houses losing their shirts. The overvalued stock market will soon follow. Even corporate debt could be swept up in this contagion. This is when the Greek debacle ends up on the front page. This is when the manicured hands of the Wall Street Welfare State start dialing their cell phones and instruct the professional politicians and central bankers to make a deal with Greece.
The situation is analogous to you buying a house with your profligate brother-in-law and splitting the mortgage payments. If your brother-in-law threatens to stop making his payments unless you make larger payments and reduce his, what choice do you have? You can tell him where to go, but then you lose the house. Or you can come to a deal.
Tsipras and Varoufakis are suggesting that the European Union inject $10 billion Euros into the Greek banking system by the end of February to give more time for the negotiations. When the European Union does this, the markets will stabilize the issue with return to the back pages and the Greeks will have won. If the European Union does not give them what they want, they will just threaten to default again.