Greek Bailout II Becomes Farcical

Another year, another Greek bailout. After months of anticipation, delays, and last-minute negotiations, the latest Greek bailout got done, but the rescue of Greece is becoming a farce.

Call it the world's most expensive do-over.

In the key elements of the plan, the European finance ministers agreed to give Greece €130 billion ($173 billion) of financial aid, pay the European Central Bank a profit on Greek bonds that are being replaced in a debt swap, and get private investors to grant Greece debt relief by taking a haircut of about 54% on their debt as part of a so-called Private Sector Involvement (PSI).

The agreement was reached early this morning European time after several self-imposed deadlines were missed yesterday. Market reaction was mixed this morning. European stocks fell, and the euro/dollar exchange rate fluctuated wildly. At one point overnight, the euro was up nearly 1% on the dollar over a 24-hour period, but the gain has since fallen back to 0.4%. US futures were close to unchanged on the news.

All in all, the market reaction so far this morning has been lackluster. First of all, the market has rallied powerfully over the last two months, anticipating some sort of Greek bailout II. Also, remember that this is simply a redo of the first Greek bailout in May 2010. The Greek economy has declined further since then, extending its four-year recession.

A looming issue for the markets is the revelation, first reported by the Financial Times and Reuters, that a confidential International Monetary Fund document casts major doubt on whether any bailout can help save the country's economy. The bailout is designed to lower Greece's debt load from 180% of GDP to 123% by 2015, but the IMF's analysis shows that many things could go wrong, because those numbers rely on some rosy assumptions about the implementation of spending cuts and the response of the Greek economy.

"In terms of trajectory, the PSI deal helps to initially reduce debt, but debt then spikes up again to 168 percent of GDP in 2013 due to the shrinking economy and incomplete fiscal adjustment," says the IMF document, which can be found here.

The problem is that, as further austerity measures are implemented in Greece, the economy is likely to weaken even further, putting pressure on the ability to raise revenue in a tax system widely regarded as broken. (Many Greek citizens evade taxes.) In fact, since the 2010 bailout and restructuring, the Greek economy has declined markedly, with the unemployment rate topping 20%. One major premise of the latest deal is that the Greek economy can heal itself and be on the path to recovery by 2013.

There are many other questions, including whether Greek authorities can implement the government cuts and other "austerity" measures required by the debt settlement.

Also, some analysts raised eyebrows at the fact that the debt haircut in the PSI deal was deemed "voluntary," thus not triggering credit-default swap insurance contracts, which could wreak havoc with financial companies. Critics ask if a 54% haircut on debt can really be considered voluntary.

In short, though the deal got done, it's a messy deal with many questions, and it doesn't inspire confidence about whether the Greek system can be saved. European entities have now plowed nearly €400 into an attempt to rescue Greece.