Greek Finance Minister George Papaconstantinou said May 2 that the European Union and the International Monetary Fund (IMF) should give Athens more time to repay the bailout funds, after already receiving an interest-rate and payment-schedule reprieve in March. This call for the restructuring of the EU/IMF bailout came as media commentary in Europe raised the possibility that Greece would restructure its private debt, defaulting on its commitments to financial institutions and private investors. These rumors started with comments by several German officials, including German Finance Minister Wolfgang Schaeuble. EU Economic and Financial Affairs Commissioner Olli Rehn and European Central Bank (ECB) Executive Board member Juergen Stark immediately criticized the idea of Greek debt restructuring. Both essentially called the suggestion preposterous, and Stark even suggested that it could lead to a greater financial calamity than the bankruptcy of Lehman Brothers, which sparked the global financial crisis in September 2008. Klaus Regling, head of the European Financial Stability Facility (EFSF), also said restructuring would not happen, suggesting that the debate may be fueled by the banks that stand to make money from restructuring via fees. The comments from Rehn, Stark and Regling — unelected supranational officials without constituencies of taxpayers and voters to satisfy — contrast with comments from German government officials and with Papaconstantinou's request. Considerations are different for the government of German Chancellor Angela Merkel, whose constituents are financing a substantial portion of the Greek bailout, and for the Greek government, whose constituents are reeling from the severe austerity measures attached to the bailout. This is why even though Greece is fully funded with the 110 billion euro ($163 billion) bailout until about mid-2012, the political impetus very well could exist in Berlin and Athens to move toward some sort of "soft" restructuring, specifically of privately held Greek debt, by the end of 2011, if not by the end of this summer.

The Logic of the Greek Bailout

Greece received the bailout package in the spring of 2010 in an attempt to prevent the sovereign debt crisis and its associated fallout from spreading to the wider eurozone. The bailout fund was not the only tool the eurozone used to avert what seemed at the time to be an existential crisis for the currency bloc. The ECB also introduced a number of extraordinary measures, the most important of which was the provision of unlimited liquidity for eligible collateral at the fixed rate of 1 percent for durations up to about 12 months. The ECB also introduced a program to purchase securities, specifically peripherals' sovereign debt, on the secondary markets in May 2010, with the aim of supporting the value of those bonds and, by extension, banks' balance sheets. (click here to enlarge image) The combined efforts of the eurozone governments, the European Commission — which partly financed the sovereign bailouts — and the ECB were meant to stave off a Greek default, which threatened to reintroduce financial instability across the eurozone by saddling European banks with yet more losses and balance sheet stress. No eurozone country had ever defaulted since the introduction of the euro, and amid the crisis, it was feared that repercussions of such an event would cause an uncontrollable chain reaction. The bailout was therefore meant to protect German and French banks holding Greek debt as much as to keep Greece from collapsing. However, Berlin always expected Greece to default at some point, as did STRATFOR — Athens' snowballing debts were simply unsustainable. The bailout package was meant to financially quarantine Greece for three years, after which time it was assumed the eurozone-wide crisis would be averted and a restructuring mechanism could be put in place to allow Greece to restructure its debts in an orderly fashion once European banks were braced for such an event. Merkel suggested as much when she said investors would have to take "haircuts" as part of the post-2013 European Stability Mechanism (ESM) rescue fund that would replace EFSF as the currency bloc's permanent financial crisis stopgap. These comments unsettled investors, whose subsequent reluctance to continue financing Dublin precipitated the EFSF bailout of Ireland at the end of 2010.

The Road to Restructuring

After Portugal became the third eurozone country to seek a bailout — and on May 3 negotiated a 78 billion euro bailout with the European Union and the IMF to be approved in mid-May — it became clear that the next concern for the eurozone is potential Greek restructuring. Two things have changed since the beginning of the eurozone sovereign debt crisis in early 2010 that seem to have the Germans considering the pros and cons of an early Greek restructuring. First, the political situation in Europe has begun to indicate a popular disenchantment with eurozone bailouts. The first outright manifestation of this was the electoral success of the Finnish True Finns party, which managed to gain considerable electoral success via appeals to anti-bailout rhetoric. Similarly, German conservative parties, including Merkel's Christian Democratic Union and her junior coalition partner Free Democratic Party, lost considerable political power during spring state elections. While these electoral losses were not purely related to the bailouts, the bailouts seem to have contributed to the loss of support for center-right parties among their traditional voting base. There is also evidence that the Free Democratic Party could become a more euroskeptic party because of its emerging conservative "Liberal Awakening" wing, particularly now that Foreign Minister Guido Westerwelle has been pushed out of a leadership position in the party. Political backlash is a problem because even after some terms of the bailout were relaxed in March, Athens wants to also restructure the pricing of the EU/IMF loans, which it claims are onerous. This is controversial because, at least from a political point of view, it appears Athens is lobbying for cheaper loans from European taxpayers so it can more effectively meet its obligations to private financial institutions and investors. After more than a year of bank and sovereign bailouts, taxpayers in Europe — or at least in Finland and Germany — have realized what this means and are demanding that private investors incur burdens as well. Furthermore, German politicians are wary of establishing a "transfer union" where Greek debts are ultimately paid off by German taxpayers. This could become politically costly in the future. (click here to enlarge image) Second, the ECB has proved to be central in limiting the extent of contagion in Europe. When considering both the amount of sovereign debt pledged at the ECB and its direct purchases thereof, the ECB has, perhaps, the most concentrated exposure to peripheral sovereign debt. Though the ECB does not disclose the nature of its holdings, it has purchased securities amounting to more than 75 billion euros in the secondary markets. Furthermore, eurozone banks, particularly those in troubled economies, have been pledging those questionable bonds as collateral at the ECB. Eurozone politicians essentially have the ECB to thank for calming the contagion danger by taking on the risk of losses — becoming a sort of "bad bank." As such, Greek restructuring would certainly affect financial institutions holding Greek government debt, but perhaps not enough to cause an existential crisis, at least not directly. And even if a crisis threatened to reach that level, the ECB now has a track record of directly intervening in the sovereign debt market to avert danger. (click here to view interactive graphic) This role for the ECB is politically convenient for Berlin and other eurozone capitals, as they can force the eurozone's central bank to deal with the losses. The world's most independent central bank, however, is not exactly keen on becoming a bad bank. This is in part why Stark was so dramatic in his criticism of potential restructuring. He understands that once the restructuring is undertaken, it will be on the ECB's shoulders to clean up the mess and incur losses. (However, the present value of the ECB's future seigniorage income — profits from printing money — is in the trillions of euros, so it would take more than losses on holdings of peripheral debt to bring the eurozone's central bank down.) This was also most likely the reason German Bundesbank President Axel Weber refused to seek another mandate as Bundesbank president, effectively removing himself from the race for ECB president. He suspected the ECB would lose a degree of its independence as politicians forced it to absorb losses across the eurozone. The purchase of government bonds on the secondary market is a particularly problematic issue for the bankers running the ECB. Weber was especially vocal in his opposition to it. ECB bankers understand the moral hazard of the move: Once it starts, eurozone politicians find it hard to resist having the ECB deal with losses already on the books and with declining sovereign debt values. Since the ECB is printing money to purchase assets, the program has been criticized as stoking inflationary fears, which the ECB has tried to calm by "sterilizing" the purchases — that is, absorbing an equivalent amount of cash from the market by issuing short-term debt, offsetting the effects of the money creation. Though the ECB does effectively remove (by issuing debt) the same amount of cash it injects (by purchasing with new money), there is a residual left in the market — the ECB bonds sitting on banks' balance sheets. As this bond is high quality and liquid, the ECB is still providing extra liquidity to the market at the margin. (click here to enlarge image) In the struggle between Europe's politicians and central bankers, however, politicians will win. The ECB will have little choice in the matter. By initiating its sovereign debt purchase program, however limited it is and however much the bank remains committed to "sterilizing" its purchases of government debt, the ECB has allowed eurozone banks and other private investors to effectively dump sovereign bonds they do not want — those most likely now to be defaulted on. That means the least-valued sovereign bonds are already on the ECB's balance sheets. And the ECB is highly unlikely to allow the effects of a Greek restructuring to spread to an economy of more consequence, such as Spain. Now that it has activated the sovereign debt purchase program and used it without hesitation, it will continue to do so. The rhetoric from the ECB, no matter how hawkish or how committed to ending supportive mechanisms, is just that: rhetoric. The alternative would be to allow the eurozone to crash and thus cease to exist, and that would be suicide for the ECB.

How a Greek Default Will Look

A Greek default, if one occurs before 2013, therefore will serve an important political purpose. Its economic and financial logic is limited. Athens does not require funding until sometime at the end of 2012. Europe's taxpayers, particularly in countries paying for an ever-increasing number of bailouts, want to see private investors shoulder part of the burden. Merkel's nominally pro-business coalition partner has even adopted some of the anti-investor language, which is popular with both right- and left-wing voters. Eurozone governments in power, led by Merkel in Berlin, therefore have a reason to stop the nascent populist movement and force some token restructuring on Greece this summer. This is especially the case since the permanent bailout mechanism, the ESM, will have to be approved by Europe's parliaments in late summer, and there is already some consternation about it from Germany to the Netherlands to Slovakia. Merkel will therefore offer Europe's agitated population a trade: forcing some investors to lose money on Greece in exchange for public support of European unity via the ESM. Like the bailout before it, Greek restructuring will come with terms that will not make it pleasant for Athens. Germany will want to illustrate to both investors and other peripheral countries that debt restructuring is not something one decides to do lightly. Athens could be forced to enact further austerity measures and potentially guarantee privatization of further public assets — a highly sensitive issue in Athens. However, since the reasons behind an early restructuring are primarily political, the restructuring probably will not go so far as to frighten investors too much. Investors largely believe that Greece will have to default on part of its debt; all of STRATFOR's investor contacts are saying they fully expect a default this summer. But STRATFOR sources in Greece, understanding that Europe conducts its policies in piecemeal fashion to reach consensus, say restructuring probably will not be enough to prevent further defaults on Greek debt in 2013. Greece's public debts amounted to 142 percent of its gross domestic product at the end of 2010, and interest payments are approaching 20 percent of government revenue (anything above 10 percent is usually considered worrisome). European voters know Greek restructuring is coming, and they understand that any Greek default will mean a default on bailouts their governments extended to Athens. There is, therefore, a mounting demand that Greece undergo restructuring soon so that it involves defaults on private investors, rather than later, when the IMF/EU bailout makes up a larger proportion of the overall Greek debt profile. Ultimately, the greatest danger to the eurozone is if Germany's voters decide that this is a problem. This is why the impetus for restructuring this summer is coming from Berlin. Finnish voters have spoken, but Helsinki does not really get a say in these matters. It is a smaller economy than even Greece, and ultimately Finland needs the European Union more than the European Union needs Finland due to the Finns' geopolitical insecurity created by their close proximity to Russia. STRATFOR never paid much heed to the idea that Finland would halt the Portuguese bailout or the ESM. Finland has succumbed to the pressures from core Europe — from Germany — and decided to agree to a Portuguese bailout before forming a new government, thus allowing the True Finns to save face. The real question is whether the "True Germans" will emerge — a development that would actually threaten to reverse perhaps all of the financial stability achieved thus far, and even the stability achieved beyond Europe's borders. This explains Merkel's wanting investors to suffer losses sooner rather than later, and why it could happen long before Athens' bailout program ends.