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Greece's debt crisis: not over yet

Greek debt explained: How big banks worsened Greece's woes, and why it's now America's problem as well.

Greece protests hit 2011 6 29Enlarge
Protesters clash with riot police in front of the Greek Parliament on June 29, 2011 in Athens, as lawmakers voted on a massive austerity package demanded by international creditors. (Alkis Konstantinidis/AFP/Getty Images)

Today, as Greek citizens rioted in the streets, the country’s parliament passed an austerity package demanded by European officials. The vote paves the way for Europe to free up $17 billion in bailout funds that the country needs to pay its debts this summer.

This is good news for the global economy. Failure to pass the measure would have triggered a financial avalanche reminiscent of autumn 2008, when Lehman Brothers crashed, nearly burying the global economy. If Greece were allowed to default, panic would have spread through the markets. Financial institutions would have stopped lending to each other, out of fear that the billions in toxic Greek debt that banks have on their books would prevent loans from being repaid. Stock markets would have tumbled. Americans would have once again lost a fortune on their 401k retirement plans. And ultimately, experts say, the U.S. Federal Reserve Bank — the world’s lender of last resort — would have been called in to rescue the global economy once again.

Passage of the austerity package was by no means certain. Protestors and police this week have exchanged tear gas, rocks and fire bombs. The sharp budget cuts and tax increases — intended to cut spending by $20 billion and raise an extra $20 billion in revenues — will bring job losses, school closures and other painful measures. Among the critics of the package was the country’s central bank governor, George Provopoulos, one of Greece’s most powerful financial officials. Over the weekend, he lashed out at a last minute $7.8 billion tax increase, calling it excessively burdensome on taxpayers.

Provopoulos statement was dangerous, increasing the likelihood that members of parliament would reject the austerity plan. But in the end, he told the Financial Times that there was no choice but to pass the measure: “For parliament to vote against this package would be a crime — the country would be voting for its suicide.”

Ironically, many analysts believe that Provopoulos was right, that the austerity plan demanded by the European Union and the International Monetary Fund as a prerequisite for further bailout funds will make matters worse.

“Who’s going to be the guy that stands up in the room at Credit Agricole or Deutsche Bank, and say ‘guys, we’ve got to stop making all this money?’”
~Terry Connelly, Dean of the Ageno School of Business at Golden Gate University

“By insisting on more austerity measures, they're just making the patient sicker,” says Laurent Jacque, a professor of international business at Tufts University’s Fletcher School. “They've put a noose around neck of Greek economy, and they're tightening and tightening it. The patient is going to drop dead.”

At a time when Greece needs to come up with as much money as possible to pay its debts, austerity threatens to stifle the economy. Over the past year, cuts have fueled a deep recession in Greece, reducing tax revenues, Jacque explains.

That brings us to the bad news: while parliament averted short-term disaster by agreeing to the austerity plan, the Greece’s crisis is by no means solved. Athens debt burden is about 160 percent of its gross domestic product. That means that if the Greeks were to stop eating, shopping and spending and dedicate every dollar they earned to paying off their government’s debt, it would take more than 19 months to pay it off. Obviously, that’s not going to happen. The fact of the matter is that Greece is effectively bankrupt, and stands virtually no chance of paying back its loans in entirety. Standard and Poor’s confirmed this earlier this month when it gave Greece the world’s lowest credit rating.

How did Greece get into this mess? How did a country with a population slightly larger than Los Angeles and an economy the size of Oregon’s manage to bring a dagger to the throat of the world economy?

The simple answer is that its government spent too much and collected too little in taxes. The country has generous social programs and pensions, and a bloated and inefficient public sector. Meanwhile, tax cheating is rife.

In fact, the problem is more complicated than that — as are the potential solutions. Greece had plenty of help in digging this hole for itself.

Some of that help came from a familiar actor, Goldman Sachs, which orchestrated a financial sleight of hand that enabled Greece to hide its extravagant ways. Before adopting the single European currency in 1999, policymakers anticipated the possibility that crises like the current one