Debt crisis: Where do a rattled Greece and EU go from here?

A stirring, patriotic speech by Greek Prime Minister George Papandreou gained him a key confidence vote, and today he vowed to set up a unity government that supports a European Union bailout and stave off spreading fears of chaos in the eurozone.  

The vote followed days of EU and world market turmoil over Greece in the midst of a G20 summit on the swanky Rivera, designed to showcase French and European elan.

Instead, the G20 became an emergency session on a deepening European debt crisis, and starkly raised the need for the reform of EU political and economic systems.

As Europe struggles to stop the euro crisis now roiling Greece from spreading more catastrophically to Italy, it seems at times more like Humpty Dumpty than Superman. Its decisionmaking appears built for good weather, not bad, analysts say.

EU leaders have relied on short-term measures that have prolonged and arguably compounded a two-year crisis that is hardly over and has sapped time and energy that could have been devoted to other constructive projects.

At the G20 summit, for example, many broader issues of global hunger, climate change, and unemployment got sidetracked.

"If 17 countries with shared history and cultures and values can't solve a problem the size of Greece, how are they going to solve problems of a bigger dimension?" asks Sony Kapoor of the Brussels think tank Re-Define. "Last year, there was still a rather limited economic problem and ample political space for the EU to deal with it.... Every delay since has created an economic worsening and shrinking political space ... and now the political situation has soured beyond belief."

Whether all or even some of the king’s men can put the eurozone together again is becoming a dire question for America’s main ally in an interconnected world. It will test whether the EU will fly apart or come more strongly together.

Time to regain confidence is now

At the G20 American President Obama and British Prime Minister David Cameron made it clear to EU colleagues that the time to regain confidence in the euro and Europe is now.   

What did get decided at the G20 is an IMF oversight team to open Italy’s books to ensure it adheres to an $80-billion plus austerity program. Italy, Europe’s third-largest economy, is running a deficit of some $2.3 trillion; on Saturday, huge crowds flooded Rome to demand the resignation of the prime minister, Silvio Berlusconi.

To be fair, the depth of the problem was not seen at first, analysts say.

While notable voices cried two years ago for the world’s wealthiest region to take a firm and early stand, there has been no clear-cut "Lehman Brothers moment" or cataclysm. Irish banks passed muster just months before Ireland needed a bailout in 2010; no event seemed to necessitate a fire wall around either Spain or Italy, Europe's third-largest economy, whose debt is now 120 percent of gross domestic product.

But in the midst of Europe's worst disarray in 60 years, its leaders are criticized for not outflanking market attacks on weak states with sovereign bank debt, and for doing only enough to stave off immediate problems.

"Markets have driven the political process in Europe for 16 months," says Thomas Klau of the European Council on Foreign Relations in Paris. "People are fed up and exhausted, but it isn't over…If the Italian government fails to inspire sufficient confidence…the crisis could move to another level.”

A bailout deal to end all deals

On Oct. 26 matters came to a head, or so it seemed. A great bailout deal to end all deals was to be struck in Brussels.

After nearly 11 intense hours that stretched into the next morning, a three-part strategy emerged, finagled by German Chancellor Angela Merkel. It spoke of a 50 percent write-off of Greek bank debt and a new bailout for Greece. As EU leaders walked out on a red carpet to waiting limousines, victory was nigh.

At least, that was the official story.

But on Oct. 31, Papandreou called a national referendum on the proposed €130 billion bailout. Its terms are hated in Greece, where it's seen as hitching the nation to decades of German-dictated austerity.

World markets toppled. Papandreou had the riot act read to him by Ms. Merkel and French leader Nicolas Sarkozy, who demanded an answer now: Does Greece wish to stay in the eurozone? The choice was so fateful that the Greek finance minister rebelled, and Papandreou backed off.

As the G20 meeting commenced, Italy's borrowing costs reached 6.3 percent – close to unsustainable. The atmosphere of market volatility was also sufficient to scotch $4 billion in EU bailout assistance to Ireland.

What vexes critics is that the vaunted Oct. 27 deal, like others since 2009, represents less than meets the eye: No new money was put on the table for the EU stability fund. Creditors' willingness to take a 50 percent "haircut" on Greek debt was not put in writing. The funds to recapitalize banks were not specified. The grand deal was but a grand band-aid, some argued.

As he arrived in Cannes for the G20, all Mr. Obama could say about the deal was that while it made "important steps ... we are going to have to flesh out more of the details."

Jean-Paul Fitoussi of the Institute of Political Studies in Paris is more blunt. "After the [Oct. 26] meeting, I said nothing happened. [EU leaders] want to increase the fund to €100 billion, but the conditions are that no state – not France, not Germany, not anyone – will put a single penny on the table. Instead, they will go ask the Chinese, who were not even at the meeting," he says. "This crisis shows that the more you wait, the more you will have to pay ... and the less credible will be the solution."

Mr. Klau is only slightly more charitable. "Some significant decisions were taken [Oct. 26], but the sum total runs far short of the scope and scale of the problem. Every part of the agreement is just an outline or declaration of intent ... important details that are relevant, but not enough."

That Europe now seeks Chinese cash for its bailout fund simply dramatizes its impotence, many argue, especially considering that Europe does not lack the wealth needed to reassure markets.

Shouts at EU leaders to stop kicking the can down the road grew so loud in October that Phil Levy of Foreign Policy penned a dissent: "Why won't Europeans just do it?" There is "a presumption that if only German Chancellor Merkel and French President Sarkozy could stop bickering and summon the political resolve, they could take the decisive set of actions to put everything right. The rest of the world can best help, the reasoning goes, by shouting exhortations at Europe to just try harder."

Eurozone problems are far knottier than realized, Mr. Levy implies.

Until Europe is treated as a common good, and not a series of battling nationalities, say reformers, no solutions will be found. A core problem is that while there is a common currency, each country has its own fiscal policy. Klau argues that the EU must become more integrated fiscally, with less power accruing to national players – easier said than done.

A main reform push is to allow the European Central Bank to act like the US Federal Reserve or the Bank of England, a "lender of last resort" that would make eurozone countries less vulnerable to market speculation. But the idea is vehemently opposed by Germany over fears of inflation. Yet inflation is not the looming threat today, say reformers; depression is. And while EU rules constrict the ECB from acting as a Federal Reserve, they also forbid bailouts.

Mr. Kapoor says that new ECB chief Mario Draghi should signal greater flexibility. "The game of chicken between the ECB and EU politicians continues, with neither measuring up to their task even as the European project is in danger of collapse." He says the Continent also needs a New Deal to create growth that austerity policies do not address. "What's needed is cross-border infrastructure development, green initiatives ... work across the continent ... that would build and create jobs at the same time."