Problems and Solutions in Growing European Crisis

Two interconnected events on Tuesday cast into sharp relief the problems Europe faces and their potential solutions. Greek Prime Minister George Papandreou announced late Monday that he will bring the ongoing Greek bailout and austerity programs to a referendum in the near future, dramatically accelerating the unfolding of the European debt crisis. Meanwhile on Tuesday, former head of the Bank of Italy Mario Draghi took over the presidency of the European Central Bank (ECB). It is not yet certain a referendum will take place in Greece. First there will be a parliamentary vote of confidence in Papandreou's leadership. Papandreou's narrow and tenuous majority makes it entirely possible that the Greek government will collapse before a referendum can be organized. As Europe’s debt woes swell, the ECB has increasingly been introduced as the only entity able to stave off complete dissolution of the euro. Additionally, until the date for and text of the referendum are finalized, it is difficult to project how Greek voters will respond. Polling data shows that while 73 percent of Greeks favor eurozone membership, 59 percent oppose the bailout deal reached Oct. 27, in which a large tranche of Greek sovereign debt is written down by half, Greek banks are recapitalized and Greece is sequestered from debt markets through the remainder of the decade. The problem for Greeks is the bailout-linked entrance of the so-called Troika — the European Commission, the ECB and the International Monetary Fund (IMF) — into Greek fiscal and economic affairs, and the painful austerity program the Troika intends to micromanage. Wildly unpopular in Greece both for its deflationary effect on the economy and for the loss of sovereignty it is perceived to have caused, the bailout and austerity package faces a substantial chance of being voted down in a referendum. And since the loss of bailout funds would certainly lead to default and a Greek exit from the eurozone, EU leaders now have a compressed time frame within which to operate and are driven by a heightened sense of urgency. As the impact of the news from Greece sunk in, Draghi took over the presidency of the ECB from outgoing President Jean-Claude Trichet. As a member of the Troika, the ECB has been instrumental in the evolving and multifaceted European bailout process. As the apex of the European banking system, it has protected banks by extending unlimited liquidity in the face of both private subprime defaults and now sovereign default. The ECB has even taken the controversial step of protecting countries directly by purchasing public debt. And it has done all of this under Trichet's relatively conservative management while keeping a lid on the money supply. As a point of comparison, the Troika's more public bailout mechanism, the European Financial Stability Facility (EFSF), has distributed less bailout funding to sovereigns — roughly 140 billion euros to the ECB's 230 billion euros — and even then only after battling for months in the parliaments of the 17 eurozone nations. As the guarantees that back the facility are increasingly committed, the source of further guarantees or capital is hard to determine — as is knowing how long it might take to get them. Another months-long process of drumming up sovereign guarantees would almost certainly be overtaken by other events. Europe doesn't have enough surplus cash, or room to add more sovereign debt. And the EFSF's scheme to attract capital from foreign sovereigns, notably Russia and China, has received a chilly reception thus far. It is therefore no surprise that Draghi enters his new post under much scrutiny and anticipation. As a citizen of one of the maligned PIIGS nations (Portugal, Italy, Ireland, Greece and Spain), Draghi is subject to speculation that his interests may align with high-debt states in desperate need of aid. If nothing else, the break with Trichet's relatively staid monetary policy has invited this line of wishful thinking from countries who want the ECB to increase its involvement in the bailout process. Regardless, as Europe's debt woes swell, the ECB has increasingly been introduced as the only entity able to stave off complete dissolution of the euro, recently by French President Nicolas Sarkozy. This brings us back to Greece. The EU's economic controls, which have so inflamed Greece and have moved the country significantly closer to a full and uncontrolled default, are the very measures that must be in place for an expanded application of the ECB's monetary powers to the crisis. Without the ability to more directly manage the finances of bailout recipients, full ECB assistance risks rewarding states instead of punishing them for their missteps. The ECB and its implicit backer Germany have thus far ruled out expanded central bank aid to states, in part for this reason. A Greek rejection of the bailout and austerity package would make expanded ECB support both more necessary and at the same time politically unpalatable to Germany. But as fiscal controls like expanded budgetary surveillance and automatic debt penalties take effect throughout the EU in the coming months, the ECB's response to the increasingly urgent crisis will come into sharper focus. As the EU attempts to navigate the interplay between fiscal governance and bailout packages, a revised strategy should begin to emerge. STRATFOR's standing forecast is that the EU, as an intrinsically desynchronized union, will break apart. The timing of such an event is still unclear, but Europe will soon collectively decide whether or not there will be one more act.