Greece’s economic crisis could signal trouble for its neighbors

Europe scrambled for ways to prop up Greece’s crumbling government finances Tuesday, restoring some stability to this unlikely keystone of the global financial system and sending markets higher around the world.

But the underlying economic problems facing Greece and some other European countries mean that radical cutbacks in government spending and more social pain are likely to follow as these countries move to avert a sovereign debt crisis, in which nations find themselves unable to pay on their obligations.

Reversals of fortunes have come fast and hard, and nowhere more so than Greece.

This Mediterranean country dumped its own currency, the drachma, in 2001 in favor of the European Union’s new currency, the euro. As a result, it gained unprecedented footing in financial markets. With Greek debt backed by the rock-solid euro, Athens raised billions from foreign pension funds and global banks at interest rates nearly as low as those offered to Germany, the fiscally conservative titan of Europe. Flush with easy money, government spending soared and the economy boomed.

But just as investors found millions of U.S. homeowners to be riskier bets than initially thought, they are now realizing that Greece — as well as other weaker economies that use the euro — is no Germany. Political handouts and padded employment rolls helped public-sector wages double here over the past decade. Rampant tax evasion — at least a quarter of the economy operates under the table — drained government coffers even as public spending soared. When the global financial crisis hit, Greece cooked the books to mask the extent of its massive budget deficit, with the fiscal emergency becoming clear only over the past few months.

Greece is now racing to push through budget cuts to stabilize its finances and convince investors of its creditworthiness before spring — when it must refinance $25 billion in debt or risk default.

On Tuesday, hopes hinged on reports that Germany may be preparing to lead a group of European Union nations in loan guarantees to Greece and other hard-hit countries in the region. Olli Rehn, who takes over as European economic affairs commissioner Wednesday, told Bloomberg News that Greece has to “do the necessary measures” in exchange for E.U. support.
Avoiding embarrassment

Another route to assist Greece may involve the International Monetary Fund. Diplomatic sources said France in particular was opposing such a move on the grounds that an international bailout in the eurozone would prove too embarrassing for Europe. Other nations in the eurozone, however, have appeared less eager to dismiss IMF support.

The news sent markets higher. The Dow Jones industrial average rose 1.5 percent, to close at 10,058, and Greek bonds and the euro rose as well.

One reason the markets reacted with such enthusiasm is that Greece’s problems aren’t its alone. Similar fears have hit nations such as Portugal, Spain and Italy, which also benefited from historically low borrowing rates but which critics say were riskier investments than they seemed.

“There are parallels to the subprime mortgages in the U.S., especially with Greece,” said Thomas Mayer, chief economist with Deutsche Bank in London. “They borrowed money on an economy with almost no manufacturing base, one that lives off tourism and agriculture. They have been living beyond their means. Even if they get short-term help from Europe, the question is still, how and when are they going to cut back?”

The answer, Mayer and others say, involves painful structural reforms that may mean significant belt-tightening for Greeks, Spaniards, Portuguese and Italians in the years ahead to justify their memberships in the eurozone. To that aim, Greece’s new Socialist government is moving to increase the retirement age, cut competition for state workers and overhaul the broken tax system.

Four major polls out this weekend showed a majority of waste-weary Greeks are in favor of the measures, even if they sting. But many state workers see the push as nothing short of an assault on a cherished way of life. Funded in part by Greek’s deepening budget deficit, Greek state workers enjoy some of the most generous benefits in Europe, receiving bonuses that can almost double their salaries, and, in some cases, the right to retire with full pensions at age 50 or even before.
Unions resist reforms

State unions are set to strike Wednesday to protest the government plan. Although most analysts predict the action will be relatively muted compared with violent strikes here in the past, labor leaders warn it is only one of several set for the weeks and months ahead.

“The message we will send the government is that the cost in social unrest will be higher than the cost of not making reforms,” said Stavros Stavropoulos, 54, an administrator in the Finance Ministry and a union activist who said he stands to lose as much as 15 percent of his $44,000 compensation package. He took to the narrow streets of Athens this week to drum up support for Wednesday’s strike.

Greece’s woes present European leaders with their biggest test of unity since the advent of the common currency 11 years ago.

Publicly, the major eurozone powers have largely called on Greece to save itself, using tough love as a warning to other member nations to get their finances in order, fast.

European leaders are set to gather Thursday for an economic conference in Brussels, where analysts expect they will make progress on an aid package for Greece and other troubled nations in the zone. A spokesman for the German Finance Ministry denied that any decision on a bailout had been reached. But few analysts think the eurozone’s major economies — Germany and France — would permit a Greek default. The Greek economy is smaller than those of some U.S. cities and accounts for only 2.3 percent of the eurozone economy. But a default here could nevertheless have an outsize effect, sparking sharp swings in the euro and investor panic in other hard-hit nations, such as Portugal and Spain.

In addition, Greece’s $300 billion debt is 80 percent owned by foreigners — mostly pension funds and banks in Germany, Britain and France that are still recovering from financial crisis. The exposure of U.S. banks to Greek debt stands at about $18 billion, according to a report by Barclays Capital.

“It is clear that the eurozone is being tested,” said George Papaconstantinou, the minister of finance. “What is being tested is the internal cohesion of the construct.”

Papaconstantinou added that he is aware of, and sympathetic to, the frustration of Greece’s larger neighbors. He vowed that Parliament will move quickly to approve the announced reforms, making them law no later than March. “I understand fully the shock and anger on behalf of Europe” given “the lack of credibility in the data and policies” of Greece in the past, he said.

Although Greece saw a long economic boom during the 2000s, analysts say successive governments failed to tackle an inefficient public sector in which wages and benefits ballooned. When the Socialist government came to power in October, its leaders discovered that their predecessors had doctored Greek financial data and that the deficit actually was 12.7 percent of the gross domestic product, double earlier figures. The realization sparked downgrades by rating agencies that triggered the sell-off in Greek bonds, as well as a sharp drop in the euro.