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The Globe and Mail

Super Mario's bank rescue no lifesaver for a dying Greece

Bravo Mario Draghi. The European Central Bank president seems to have prevented, or at least greatly reduced, the odds of a potentially catastrophic Lehman Bros. moment on European soil.

He did so by pumping almost €500-billion ($655-billion) of cheapo loans into the euro zone's dying banks. Italy's banks alone sucked up €50-billion of the emergency loot. A blowup of a bank the size of Milan's UniCredit would have hit the industry like a cluster bomb.

The question is whether "Super Mario" Draghi saved the banks from mass suicide because he knows, or suspects, that the big financial and economic cataclysm lies just around the corner. That would be a Greek default. Even if its default were orderly – that is planned and executed with all the efficiency of a U.S. Chapter 11 bankruptcy case – the damage across Europe would be ugly.

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But don't forget that this is Europe, where delays, waffling and shoddy planning are the rule, not the exception. A disorderly default cannot be ruled out. In either scenario – orderly or disorderly – the European banking giants, most of which are heavily exposed to rotting euro zone debt, would take severe hits. To his credit, it appears that Mr. Draghi propped them up in anticipation of the worst.

But hold on. Isn't Greece in the final stages of a private sector debt restructuring effort that will a) crunch its national debt load, b) open the door to a second bailout and, c) keep it merrily in the 17-country euro zone?

That, at least, is the idea. After months of on-again, off-again negotiations, the effort to whack the value of the bonds held by private investors (mostly banks) by 50 per cent is back on track. If the "haircut" succeeds, Greece's overall market debt would fall by about €100-billion, taking it down to €260-billion. That alone would save Greece about €4-billion a year in interest payments.

What's not to like? Plenty, as it turns out. If you think Greece, sinking ever deeper into the recession hellhole, can survive, let alone thrive, with €100-billion less debt, we've got a deal for you on a nice little Athens bank. And we'll throw in the subsidiary branches in Portugal and Ireland for free.

Barring an economic miracle, like China's sovereign wealth fund suddenly taking the view that Greek debt is the steal of the century, Greece is dead, doomed, defunct, departed.

Let's start with the haircut. If there's 100 per take up among the private bond holders, if the bond holders accept cut-rate replacement bonds with, say, a 4 per cent coupon, and if nothing else goes wrong, then Greece's debt load would fall to about 120 per cent of gross domestic product. Lot of ifs there.

But if the haircut meets resistance – it's voluntary – and the debt exchange attracts only a few punters, then Greece's debt load would exceed 145 per cent of GDP in 2012, the International Monetary Fund says. If that weren't enough, there's the small matter of €37-billion of Greek bonds due to mature this year, of which about €27-billion are privately owned. There is no budget to redeem these bonds, according to Société Générale.

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Let's be optimistic and assume a debt load at 120 per cent of GDP would buy Greece some time (seconds, months?). It would do so only if the economy were to stop doing a credible imitation of the Costa Concordia. Remember that Italy is groaning under a 120 per cent debt-to-GDP load and its economy is about 187 standard deviations healthier and more diversified that Greece's.

The Greek economy is still in freefall. It contracted 3.5 per cent in 2010 and about 6 per cent in 2011. In spite of nasty austerity programs, its budget deficit – at 9.5 per cent of GDP – barely improved last year. The deficit may see only a tiny improvement again, for the simple reason that the International Monetary Fund and the European Union, the sponsors of the Greek bailouts, insist on keeping their medieval torture intact. The formula works perfectly: More austerity, deeper recession, less government income followed by demands for more austerity as deficits remain intact.

Meanwhile, on street level, the working economy is in tatters. Private sector wages are sinking rapidly. Inflation remains oddly high. The result, according to Société Générale, is that real wages are falling by about 10 per cent year on year. The banks are train wrecks. The dud loan count is now 13 per cent of total loans and retail deposits are vanishing. The Bank of Greece, through emergency liquidity injections, is keeping the Greek banks alive.

If the bond haircut works out, Greece is supposed to get a second bailout, worth €130-billion. If the haircut doesn't work, Greece would probably default in March, when a €14.5-billion bond redemption is due. Haircut and bailout or not, Greece is dying. It needs to remove itself, or be removed, from the euro zone and print drachmas in the hope of devaluing its way back to something approaching economic stability.

There is little doubt that Mr. Draghi knows the jig is up in Greece, if not now, soon. Flooding the banks with cheap loans was his way of protecting them before the inevitable happens.

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