- The Washington Times - Friday, April 9, 2010

The Greek debt crisis broke out anew in recent days amid worries that Greece will not be able to overcome public opposition to deep budget cuts while support from the European Union remains wobbly and depositors appear to be staging a run on Greek banks.

The renewed crisis makes it likelier that Greece will need a bailout from the EU within weeks, analysts said, posing the first major test of the trading bloc’s resolve to maintain unity in the face of immense fiscal problems in Greece and a long list of other member countries.

Greece’s borrowing costs soared Thursday to a record 4.63 percentage points over the rates on German bonds, raising questions about whether Greece will be able to reduce its sky-high budget deficits even if it adheres strictly to deep budget cuts that have sent Greek citizens and labor unions into the streets in protest for weeks on end.

The beleaguered nation was pushed further against the ropes by an exodus of depositors from Greek banks in January and February and other bank funding problems that forced the country to exhaust funds it had set aside to shore up the banking system - leaving Greece with little wherewithal to address any further assaults on its teetering financial system.

Adding to Greece’s woes, divisions reopened between Germany and other EU nations in recent days over the terms of aid they had pledged to provide Greece last month. Germany continued to insist that any loans to Greece should carry interest rates close to market levels, to discourage Greece from seeking a bailout, while France and other EU members favored providing subsidies to reduce the financial strain. Other questions surfaced about the concessions Greece would have to make in return for an International Monetary Fund (IMF) contribution to the backup financing plan.

“It’s another Greek blowout,” said Mark Frey, an analyst at Custom House, a Canadian foreign exchange firm, noting that the drama and complications surrounding the Greek financial tragedy are getting more tangled and histrionic by the day.

“The much-ballyhooed EU and IMF partnership cobbled together seemingly at the last minute in order to provide a backstop to Greece and lower the heavily indebted nations borrowing costs is unraveling, with more than a few eyebrows being raised at how we got to this point,” he said.

“If a workable financing arrangement cannot be realized, the world is ultimately relying on Greece to enact painful fiscal austerity measures in an environment where the populace has been completely unwilling to accept that there is a significant problem to begin with,” he said.

“Furthermore, going the IMF route is likely to have spending restrictions that equate to political suicide and, as such, Greek politicians will want to avoid the IMF. So, by no means have Greeces debt woes been resolved.”

The EU/IMF backstop plan was originally designed last month to try to help stabilize Greek markets, thereby enabling Greece to keep borrowing on its own and addressing its own budget problems without a bailout.

“Unfortunately, the eurozone bailout plan has failed to have the positive impact expected,” said Diego Iscaro, an analyst at IHS Global Insight. “The situation in Greece continues to be extremely worrying.”

Given the intransigence of the Greek problems - and the EU’s inability thus far to convincingly address them - the crisis is beginning to spread again after a hiatus of several weeks, driving up the borrowing rates for similarly debt-strapped European countries such as Portugal, Ireland, Italy and Spain.

As in previous episodes, Greece’s renewed woes drove down the euro Thursday close to its lowest point against the U.S. dollar this year. Meanwhile, the value of the dollar and prices on U.S. Treasury bonds, where investors often stow funds during financial emergencies, increased. The heightened support for U.S. assets enabled the U.S. Treasury to enjoy a successful auction of a heavy slate of securities this week.

“With attention having turned to the Greek-yield explosion, we saw a flight to quality bid in Treasuries,” and heavy buying of Treasuries by foreigners, said John Rocket Spinello, chief technical strategist at Jefferies Inc. He expects the “ongoing Greek saga” to keep driving investment into U.S. markets while hurting the European currency and markets.

Adarsh Sinha, an analyst at Barclays Capital Research, said the threat to stability from a run on Greek banks may have been exaggerated. Greek depositors, he said, may have decided that they can earn more by putting their money in Greek government bonds offering interest rates of more than 7 percent.

“It might be that these deposits are being moved to foreign banks, but it could also be that they are being put to work in some way,” he said. “Clearly, such deposit-flight stories can be self-fulfilling.” And in any case, Greek banks likely are offsetting flows of deposits into Greek government bonds by cashing in some of their own Greek bond investments to pay off the depositors.

“Fears about a vicious circle developing will likely remain alive,” and ultimately may force Greece into the arms of the EU and IMF, he said. But the cost of IMF involvement will no doubt be high.

“Previous experience suggests that the IMF would prefer a larger upfront fiscal adjustment from Greece - in exchange for large upfront financing - that could include concrete commitments on such contentious areas as pension reform,” he said. Barclays estimates that Greece will need a three-year joint IMF/EU package totaling 40 to 45 billion euros as the “minimum needed” to “calm markets sufficiently” so that Greece can continue to slowly overcome its budget and financial problems.

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