German Chancellor Angela Merkel refrained from commenting for three long days as the value of Greek bonds continued to fall. The chancellor knew she had to say something to put a halt to the nose dive. Something needed to be done to defuse the ticking time bomb threatening Europe and the euro: the possible bankruptcy of European Union member state Greece.
Speculators in the trading rooms of banks had been waiting for a signal. They wanted to know whether EU member states were going to rush to the aid of the financially hemorrhaging country on the Aegean. The longer they waited, the further Greek bonds slipped -- and the closer the country slid toward national bankruptcy.
Merkel doesn't believe that Greece can cope with its problems without help from Brussels -- regardless of whether the Stability and Growth Pact prohibits such aid or not. That's what she told close advisers in the Chancellery on a number of occasions.
Any promise of aid though would only undermine the willingness of the Greeks to take tough measures to bring their runaway deficit under control without outside help -- and that is exactly what Merkel wants to avoid.
So the chancellor attempted a balancing act: "We bear a collective responsibility," she said last Thursday shortly before a meeting of EU heads of state and government in Brussels, where Greece's financial situation was also on the agenda. When a member country has problems, it concerns all of us, Merkel said. This makes it necessary to discuss how the community can intervene in the policies of countries that have amassed large mountains of debt, she added.
It was a weak signal, but it sufficed for the time being. Prices of Greek bonds recovered slightly after they had plummeted at the beginning of the week. Last Monday, the rating agency Standard & Poor's had given Greece a negative outlook, and one day later its competitor Fitch substantially downgraded the country's creditworthiness from A- to BBB+. That is the worst rating that a country in the euro zone has received since the introduction of the common currency in 2002.
Suddenly the fear of a financial crisis reared its ugly head again -- the fear of a second wave that would not hit the banks this time, but rather the countries who could not pay their debts. First Dubai, then Greece, then what?
A wave of nervousness spread to the stock exchanges -- where prices fell -- and to the capital cities of the EU, the finance ministers' meeting in Brussels, Germany's financial center in Frankfurt and even to the headquarters of the International Monetary Fund (IMF) in Washington. Everyone was asking the same question: What happens when a country, even a member of the European monetary Union, goes bankrupt? Can the EU allow this?
In any case, the EU cannot push Greece out of the euro zone and leave the country up to its own devices, although the Greeks did cheat their way into the common currency club with the aid of fudged budget figures, as Axel Weber, president of Germany's central bank, the Bundesbank, recently made clear at a board meeting.
Does Greece Have Far Higher Debts?
The alarming nature of the situation is reflected by the fact that the IMF is taking up the issue. According to sources in the German Finance Ministry, a visit in the coming weeks by IMF officials assigned to Greece will have the character of a special audit.
The IMF has serious doubts over whether Greece's projected deficit for this year, which was revised from 6 to 12.7 percent, is in fact realistic -- or whether it is actually much higher. Government officials in Berlin and Germany's central bankers in Frankfurt share this view, and some of them even see the BBB+ rating as "almost flattering."
According to the standards applied to private individuals, Greece would already be insolvent today, despite the fact that it has continued to service all its debts. This is due to the enormous outstanding debts that government agencies and ministries have in the private sector. These claims amount to over 10 billion ($14 billion) and the Greeks owe over 2 billion to German companies alone. Taking these sums into account would cause the Greek deficit to rise even further.
"We have made provisions for most of these claims," says Greek Finance Minister Giorgos Papakonstantinou (see the accompanying interview here). He points to the efforts of the new government under Prime Minister Georgios Papandreou to reduce the deficit in the coming year and regain the confidence of the financial markets.
There is also a lack of trust in Greek promises within the EU. All too often in the past the Greeks have vowed to make improvements. In Berlin and Brussels politicians are increasingly grappling with the question of how to effectively help the Greeks.
There appears to be little doubt that the EU will take action -- after all this concerns the future of the euro, and perhaps even the future of Europe. If the EU actually allows a member state to go bankrupt, it could spark a chain reaction. Long ago Standard & Poor's put Spain on the list of countries whose credit rating is on the verge of being downgraded. Portugal, Italy and Ireland could also be drawn into the downward spiral of declining bond prices, higher interest rates, more expensive debts and thus a higher deficit. On top of that there is the ballooning budget deficit of £175 billion ($285 billion) in Great Britain -- a core country of the Continent, even if the euro is not legal tender there.
Europe might perhaps be able to afford to let a country go bankrupt, just as the US was able to cope when California went broke. But what if this happens to a number of EU countries? That would trigger what euro skeptics have warned about right from the start: The European common currency would collapse.
But the trouble wouldn't stop there. When government bonds that have been regarded as a safe investment suddenly become worthless, then the banks start to wobble again, except in this case there would be no more governments strong enough to support them.
Nonetheless, even an isolated Greek bankruptcy would be bad enough, both economically and politically. Greece is already shaken by violent demonstrations, and political unrest could not be ruled out if the country descended into financial chaos.
What should be done to head off this Greek tragedy? The members of the board of the Bundesbank have a clear opinion on this subject. They say that if the country went bankrupt, Europe should under no circumstances come to its aid. Otherwise the Stability and Growth Pact would become nothing more than a historic document, with no relevance for the present or even the future. If help is required from other countries or international institutions, then the IMF should step in, say the bankers. After all, one of the key missions of the fund is to provide this type of aid.
Many heads of state and government, including Merkel, would like to keep the IMF from getting involved anywhere in the euro zone. This is primarily because they feel that the Europeans must solve their currency problems alone. Outside help would only undermine confidence in the euro. The chancellor instead advocates establishing an instrument on a European level that would resemble what the IMF already has in place. In other words, money would only flow in exchange for tough and wide-ranging preconditions. This would significantly limit a country's sovereignty.
The Greeks, for example, might have to accept a budget inspector -- or be forced to raise their taxes so that a predetermined sum of money can be raised through additional revenues.