A Greece Fire

If you have paid any attention to international news at all, you are aware that Greece is in the throes of an economic crisis, one which economists and political pundits say may be headed to the United States of America.

Well, things have escalated in that ancient land.  Reuters.com has the details:

The Greek parliament approved a deeply unpopular austerity bill to secure a second EU/IMF bailout and avoid national bankruptcy, as buildings burned across central Athens and violence spread around the country.

Cinemas, cafes, shops and banks were set ablaze in central Athens as black-masked protesters fought riot police outside parliament.

State television reported the violence spread to the tourist islands of Corfu and Crete, the northern city of Thessaloniki and towns in central Greece. Shops were looted in the capital where police said 34 buildings were ablaze.

Prime Minister Lucas Papademos denounced the worst breakdown of order since 2008 when violence gripped Greece for weeks after police shot a 15-year-old schoolboy.

“Vandalism, violence and destruction have no place in a democratic country and won’t be tolerated,” he told parliament as it prepared to vote on the new 130 billion euro bailout to save Greece from a chaotic bankruptcy.

Papademos told lawmakers shortly before they voted that they would be gravely mistaken if they rejected the package that demands deep pay, pension and job cuts, as this would threaten Greece’s place in the European mainstream.

“It would be a huge historical injustice if the country from which European culture sprang … reached bankruptcy and was led, due to one more mistake, to national isolation and national despair,” he said.

The chaos outside parliament showed how tough it will be to implement the measures. A Reuters photographer saw buildings in Athens engulfed in flames and huge plumes of smoke rose in the night sky.

“We are facing destruction. Our country, our home, has become ripe for burning, the centre of Athens is in flames. We cannot allow populism to burn our country down,” conservative lawmaker Costis Hatzidakis told parliament.

The air in Syntagma Square outside parliament was thick with tear gas as riot police fought running battles with youths who smashed marble balustrades and hurled stones and petrol bombs.

Terrified Greeks and tourists fled the rock-strewn streets and the clouds of stinging gas, cramming into hotel lobbies for shelter.

How did one of the cradles of ancient civilization come to resemble the Watts riots?

Dave Backus of New York University’s Stern Business School, shared his thoughts:

Debt and deficits. Greece in serious budget trouble, with government debt at 125% of GDP and rising. Confidence in Greece has fallen with repeated upward revisions in deficit estimates, which raise suspicions that the situation is worse than reported.

Contagion? Greece itself is small, but there’s fear that if Greece defaults or leaves the Euro Zone (or perhaps some other dire event), there could be spillovers to other Euro Zone countries (Italy, Portugal, and Spain lead the list). One version of this is that it would undercut the credibility of the Euro Zone. Member countries have (generally) reduced their borrowing costs by eliminating currency risk, but if investors see membership as reversible, that could change quickly.

Conditions for help. The policy challenge is to keep the problems in Greece from spreading without creating adverse incentives for other countries. A bailout, for example, might make other countries less likely to resolve their own budget problems (mumble “moral hazard” around now). The traditional solution is some kind of “conditionality,” in which bridge loans are tied to concrete progress on the budget. IMF programs typically have this form, and the NYC bailout in the 1970s did, too. Such conditions solve the budget problem and make bailouts less attractive to other countries. When imposed by an outside agency (the IMF, for example), they may also provide political cover (“they made us do it”).

Who? The challenge in the EU is that the rules explicitly forbid bailouts, so there’s no natural agency to execute a plan. That leaves us with ad hoc mechanisms (the finance ministers, for example). Or maybe the IMF.

Euro Zone. It’s an inherently weak structure, since there’s no strong political entity at the top to enforce decisions on member countries.

Who’s next? There are several other EU countries with budget problems. And in the US, many (most?) states have serious budget problems, California being the biggest one.

According to Money.MSN.com, our country could take a hit from the falling dominoes in the wake of a Greek default.

Exactly how far the damage would go depends on to which degree that bond markets would punish the bonds of Portugal, Ireland, Italy and Spain, which, along with Greece, make up the so-called PIIGS group. The exposure of U.S. banks to Greek debt alone is relatively small. But U.S. banks have $670 billion in total exposure to the PIIGS group.

Given the disastrous domestic economic failure that is the Obama Administration, the fallout from a potential European economic disaster would be the icing on a very toxic cake.

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