Is Greece Too Big to Fail?

We've talked about the dire situation in Greece here before, and now the situation has come to a head: Greece has chosen austerity, much to pleasure of EU officials and displeasure of Greeks, who begun massive strikes. Whenever I hear about a macroeconomic development in the EU, I turn to the indispensable A Fistful of Euros for comment. Edward Hugh doesn't disappoint:

[Public statements from EU officials] have been widely interpreted in the international press as a “no” from Germany and France to any EU bailout of Greece. But is this interpretation justified? Before going further, I think it should be pointed out that the whole argument depends on what you consider a bailout to be. If you take the view that a bailout involves a restructuring of Greek Sovereign Debt, with the EU itself offering to pay a part, then this is clearly not on the cards, at least at this point, and let’s take things a day at a time. But if you consider the “bailout” which is under consideration at the present time to be simply a loan, which in some way shape or form (yet to be determined) would be guaranteed by the EU institutionally, and would thus be available at a cheaper rate of interest than the one the markets are currently charging, then it is hard to see how British or German taxpayers would be having to finance anything, except in the unikely event that Greece were unable to repay.

In other words, the EU is now facing a situation with the sovereign debt of its member states somewhat similar to what the US Treasury and Fed faced with American banks in late 2008: they don't want to fully bail them out and thus exacerbate the moral hazard already in the system, but they also don't want to let them fail and spread contagion throughout the system. Like the US banking "bailouts", there is reason to think that both fates can be avoided by extending credit at attractive rates to cover a short-term liquidity crunch, and that this can be done at limited taxpayer cost (or even potential profit).

But unlike the US Treasury and Fed, the EU seems to be holding out for its pound of flesh: austerity measures, or no funding. Normally this is the purview of the IMF, and that organization is waiting in the wings:

“The IMF stands ready to support Greece in any way we can,” Mr Lipsky said. “It is a matter for the Greek authorities to decide, in collaboration with the European Union, but we are here to help if we are wanted.”

But the ECB seems to want to keep this in-house, perhaps in an attempt to shore up the credibility of the union and forestall the possibility of contagion: if Greece can't get its house in order, then other troubled eurozone economies like the other PIGS (Portugal, Italy, Greece, Spain, to which we can maybe add Ireland) may find their costs of borrowing rise, making it more difficult to service their debts. The ECB is quite rightly concerned about the integrity of the union. The Greek debt crisis may have far-reaching ramifications for European politics.