The Greek national government doesn't have the cash to service its debt and private parties aren't willing to lend it any more. The natural solution would be for Greece to default and restructure its debt. Those who imprudently lent to Greece would incur a loss. The Greek government would have to curtail its spending to match what it could raise in taxes and from more demanding lenders.
Instead, euro zone countries cobbled together a $145 billion bailout package, designed to relieve Greece from the need to raise private capital for a couple of years.
Rather than calm anxiety about euro zone sovereign debt, rate spreads between fiscally shaky countries (such as Spain, Portugal and Ireland) and sounder ones (principally Germany) increased sharply.
So, euro zone countries cobbled together a $955 billion bailout fund over the weekend for all euro-denominated sovereign debt.
The rationale is supposedly to prevent contagion. There are two fears. One is that the default of any euro zone country on its public debt would have cascading effects on the economies of other countries. The second, more profound, fear is that the default on any euro-denominated sovereign debt would adversely affect all euro-denominated sovereign debt and the euro itself.
These fears would seem grossly overwrought. Banks and other private parties in other countries hold Greek debt, but not in the sort of concentrations to represent serious contagion risk.
The euro is a currency, a medium of exchange. The default of one borrower in a particular currency doesn't reflect upon the creditworthiness of other borrowers using that currency or the soundness of the currency itself. Indeed, as Greece was finding it more expensive to borrow, Germany was finding it less expensive.
These bailouts will have serious adverse consequences, for Greece and the euro zone's future.
Greece has to undergo a severe austerity program. If the spending cutbacks were because Greece defaulted on its debt and couldn't borrow any more money, the Greeks would have no one to blame but themselves.
Instead, the austerity program comes as a condition of the bailout funds from other euro zone countries and the International Monetary Fund. So, there are strikes and riots in Greece, claiming that the spending cuts are unnecessary and are being foisted on Greece by nefarious outsiders.
Some think that this is good, allowing local officials to take painful action while outsiders get the blame. But that does not make for a healthy democracy or more prudent future political choices.
Rather than contain contagion, these bailouts actually institutionalize it. Basically, the euro zone countries have said that we are no longer independent political economies that share a common market and a currency. Instead, if any of us are sick, then all of us may have to pay the hospital bill.
And they increase doubts, rather than alleviate them, about euro zone public finances and the soundness of the euro.
Most of the larger $955 billion bailout package takes the form of off-budget borrowing that nevertheless will be guaranteed by euro zone countries. So, the solution to too much government borrowing is even more government borrowing, only less transparent and secure.
And for the first time, the European Central Bank will buy dodgy sovereign debt private investors are shunning. The ECB says it will offset these purchases with the sale of other assets to avoid expanding the monetary base. But that means that the ECB will be trading good securities for bad ones. Regardless, monetizing sovereign debt isn't a path toward either fiscal discipline or a sound currency.
Prior to the bailouts, Greece's fiscal indiscipline didn't really jeopardize the euro zone enterprise. Now it does.