Each of us has a credit rating. It is based on our estimated ability to repay borrowed money and it depends on our income, our debt load and our track record in paying off loans taken out to buy everything from holidays to high-definition TV systems. Governments are no different. They have credit ratings too, and when they go the wrong way, they can break economies and lead to unpleasant outbursts from angry public employees on strike.
In the European Union, Greece is the equivalent of the free-spending consumer living beyond his means, and whose ability to repay big debts is at now risk, at least according to the credit rating agencies. Each of the three biggies - Fitch, Standard & Poor's, and Moody's - has downgraded Greece in recent weeks.
The latest came on Tuesday, when Moody's judged the Greek government's austerity plan insufficient to rein in soaring deficits, at least not in the short run. The latest Fitch downgrade, on Dec. 8, marked the first time in 10 years that a ratings agency put Greece below the desired A investment grade. Fitch's new triple-B-plus rating puts Greece uncomfortably close to junk status.
What now? What if Greece teeters on the edge of bankruptcy? After considerable debate, the EU has adopted a tough-love strategy for Greece - no bailout coming. That means the other ailing PIIGS (the acronym for Portugal, Italy, Ireland, Greece and Spain) won't get one either, though a disaster scenario might trigger an International Monetary Fund rescue mission.
The no-bailout approach - if it sticks - is a good thing even if it means Greece is lost in the wilderness of fiscal pain. An EU bailout of Greece or the other piggies wallowing in the muck of debt would be the equivalent of a reward for bad behaviour. Rather than protect Ireland and the EU's vulnerable southern flank, a bailout would do the opposite.
Still, casting Greece adrift was no easy decision. A two-day EU summit in Brussels earlier this month pondered both the love and tough-love strategies. German Chancellor Angela Merkel, whose government can now claim ownership of the EU's safe-haven bonds, appeared to take pity. She said the 27-EU member states shared a "common responsibility" for Greece. She hinted that the countries in the "greatest difficulty" should receive help, for the sake of euro currency stability.
The debate goes well beyond the merits of country bailouts. There was a different debate early this year, during the thick of the financial crisis. That's when the interest rate spreads between the bonds of the high-debt, high-deficit countries (Ireland and Greece, for example) and the fiscally strong countries (Denmark and the Netherlands, among a few others), went from fairly narrow to gaping. Spreads of 100 basis points or less - 100 points equals one percentage point - suddenly widened to as much as 300 points.
The widening spreads triggered the inevitable finger pointing. Maybe the risk pricing isn't rational. Maybe Greece and the other PIIGS are being unfairly punished by the global bond markets' sadist traders.
At that point, Joaquin Almunia, the EU's commissioner for economic and monetary affairs, floated the idea of a common euro bond. It would replace the bonds of the individual governments - the EU has no equivalent of U.S. Treasuries. An EU superbond, arguably, would be less volatile that any of the national bonds. It would be highly liquid, making it a viable competitor to U.S. Treasuries.
It was a bad idea then and it's a bad idea now. Governments, like lazy office workers, naturally take the path of least resistance. An EU-wide bond would not impose fiscal discipline; it would allow the lax countries to get away with murder. In a note published on the Vox economists' site this week, author Ludger Schudnecht, an economics adviser to the European Central Bank, and his colleagues said a common bond would mean "a country could get away with low fiscal discipline without being punished with a higher cost of borrowing by financial markets."
The authors had a better idea. Governments should create fiscal cushions when economies are on a roll, all the better to soften the blow when the bad times come. Canada did this in the years before the financial crisis, by eliminating deficit spending and trimming debt. Spanish banks use a version of the same strategy. Regulations require them to build up their loan-loss provisions in good years so they can draw them down in bad. As a result, Santander and other big Spanish banks are performing well even though the Spanish economy is stuck somewhere between recession and depression.
In the meantime, Greece is going through hell. The socialist government of George Papandreou disclosed its 2009 budget deficit will be 12.7 per cent of gross domestic product, more than double the previously announced figure. The goal is to trim it to 9.1 per cent in 2010, which is still three times higher than the EU's economic stability rules allow. The government slapped its citizens with a 10-per-cent cut in social security spending, abolished bonuses at state banks and nailed the bonuses of private bankers with a 90 per cent tax. The pension system is to be overhauled and the wealthy are to bear more of the tax burden. Last week, Athens and other cities were hit with demonstrations and strikes protesting the austerity measures.
Greece could go either way. The EU estimates its national debt will rise to 125 per cent of GDP next year, the highest in the EU. Absent an economic turnaround, Greece could go bankrupt, require an IMF bailout or even be forced to drop the euro and go back to the old drachma, which could be devalued. For Greece, living the high life for years is coming at a high cost, as it should.