Why All the Drama? Let Greece Default

Enough with the on-again off-again referendum. Enough with the incremental bailouts that require increasingly harsh austerity measures imposed from above on Greek citizens. And enough with the escalating political drama in Athens.

None of it’s working. It’s just making the situation worse.

Greece should simply default on its massive 350 billion euro debt, cut its losses and move on. By shedding its larger sovereign debt Greece could use the money to scale back on some of the more onerous austerity measures and to cover other debts, such as public employee pensions, that could help quell the country’s rising social unrest.

Europe could move on, as well, isolating the problem to that single, relatively inconsequential country (Greece accounts for just 2.5% of the 17-member euro zone’s GDP), which would free up time, energy and resources to address similar but (so far) less critical debt problems in Italy, Spain and Portugal.

“If you think about how much time and energy is being spent on something that seems inevitable, why not focus your resources and energy on building and saving what can be saved,” said Peter Tchir, founder of TF Market Advisors in Connecticut.

The longer default is avoided the messier the process will be, and the wider the impact will be across Europe and around the globe.

“I think they should have done this a while ago. The expectation that it’s somehow going to be better in the future hasn’t played out,” said Tchir. “Normally you try and quarantine contagion risk. The longer they wait the larger the risk of contagion.”

The first bailout came in May 2010, when Greece received a 110 billion euro loan from the European Union and the International Monetary Fund contingent on higher taxes and sharp cutbacks in government spending.

Protesters led by government workers who stood to lose their jobs and/or their generous pensions and benefits rioted in the streets of Athens -- and the bailout didn’t help anyway.

Last week European leaders put together another rescue package that would force private Greek debt holders to take a 50% haircut and funnel another 130 billion euros to Greece. Even harsher austerity measures were required as part of that bailout.

Greek Prime Minister George Papandreou’s unexpected call for a referendum on the latest rescue has thrown Greek government into chaos and prompted European leaders to demand of Greece whether it plans to remain in the European Union or strike out on its own, a virtually unthinkable move not long ago.

All of this drama simply to avoid a Greek default. It’s all unnecessary and ultimately harmful in the long run.

Jeffrey Miron, a senior lecturer at Harvard University, makes a succinct case for default.

“Default helps Greece by allowing a depreciation (of debt) and by escaping bad austerity measures,” he wrote in a message. While default will hurt some in Europe, namely those who own Greek debt, it saves untold billions of euros in current and future bailout funds “that would probably not have worked anyway,” he said.

Moreover, Miron said default would bring clarity to a long-running crisis that has roiled global financial markets for months. It “gets things settled so more of Europe knows who owes what to whom.”

Besides, default wouldn’t be the end of the world for Greece or Europe -- or the world, for that matter.

“If you start looking at what really happens the problems are surmountable and it’s been done in other countries. It gets your books in order and helps you get to sustainable debt levels. I don’t see it as being so dramatic. I don’t think it’s the apocalypse. It’s a part of evolution,” said Tchir.

Countries defaulting is hardly unprecedented.

Argentina defaulted on its sovereign debt in 2002 after a deep four-year recession. Social upheaval followed, including riots, bank runs and political turmoil. And for several years Argentina was blackballed from global capital markets. But investors have since returned as Argentina’s GDP has risen steadily in the ensuing nine years.

In 1998 Russia, still struggling to rebuild from the collapse of the Soviet Union, defaulted on its debt. But by leveraging its vast oil reserves and industrial might, Russia has since re-emerged as a global power.

In several years, once Greece inevitably gets its fiscal house in better order, it’s a good bet high-yielding Greek bonds would find an audience with investors willing to take a risk.

The interim would be difficult for Greece, no doubt about it. The institutions holding Greek debt -- primarily big European banks, smaller Greek banks and Greek pension funds -- would take significant hits.

And world markets would likely plunge temporarily as investors mulled the long-term impact. But once European leaders faced the reality, reined in the contagion and shifted their efforts to growing problems in Italy and Spain, markets would undoubtedly recover.

The smart thing to do for Greek fiscal leaders would be to channel money saved in a default back to debt holders with close ties to the Greek people. Namely, the local Greek banks and pension funds.

Forcing the big European banks to eat the largest share might help placate Greek citizens who also risk losing their savings in the aftermath of a default.

“It’s a much easier pill for Greeks to swallow if they see the European banks take a hit, and they might also be willing to accept changes to their pensions,” said Tchir.

Greece would also no longer be beholden for the next decade to Europe’s demands for austerity. The country could forge its own path back to some level of fiscal stability, a path that might include the sale of valuable assets such as strategically important Mediterranean ports to China or some other developing power.

What’s more, the morale of angry Greeks might rise knowing their government essentially told Europe to “buzz off,” Tchir said.