Hobson's Choice for Germany, ECB

By Richard Barley
The Wall Street Journal
Wednesday, April 28, 2010

http://online.wsj.com/article/SB10001424052748704471204575210413650656220.html

The euro-zone crisis risks spinning out of control. The Standard & Poor's downgrades of Greece to junk status and Portugal by two notches to A-minus, although only confirmation of what markets prices were already saying, may have broken already fragile investor confidence. The single currency's fate is now in the hands of the German government and the European Central Bank. None of the choices on offer are good ones.

Germany must decide whether to commit its highly reluctant taxpayers to a vast Greek bailout. If the package is too small, markets will conclude the euro zone is unwilling and unable to support its members, triggering contagion to other countries and a possible break-up of the euro zone. But if Germany agrees a big enough package to draw a line under Greece's funding problems for several years, as investors seem to be demanding, it must do so aware it is unlikely to get all its money back. After all, investors now suspect Greece's problem is one of solvency rather than simply liquidity.

The ECB's challenge is no less crucial: It must decide whether to continue accepting Greek government debt as collateral for its lending operations if all three major ratings firms downgrade it to junk. Under ECB rules, already weakened once to accommodate Greece, eligibility requires at least one investment-grade rating. Moody's Investors Service still rates Greek debt four notches above junk. It may retain that investment-grade rating if an aid package materializes—after all, global banks remained investment-grade even after Lehman's collapse, thanks to government support. But S&P's three-notch downgrade shows how quickly the situation can change.

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For further reading:
"Opa! Greek Government Announces Yet Another Bailout, But Who is Really Getting Bailed Out?", The Agonist, May 3, 2010
"Germany Clears Rescue for Greece", The New York Times, May 3, 2010
"Greek Money Mystery", Adrian Ash, May 3, 2010
"The Euro Trap", Paul Krugman, April 29, 2010
"Sovereign Debt Crisis Past the Point of No Return?", Financial Advisory, April 28, 2010
"ECB may have to turn to 'nuclear option' to prevent Southern European debt collapse", Ambrose Evans-Pritchard, April 27, 2010
"The Euro Can Survive a Greek Default", Daniel Gros, April 26, 2010