IMF and EU engage in brinkmanship while Greek bailout fails

The IMF upped the ante in its efforts to get the EU to address the fundamental problems underlying the financial crisis.

Specifically, it called for government institutions, like the ECB, that hold Greek debt to grant Greece debt relieve by writing down this debt.

Naturally, the EU refused.

As the Guardian's Ian Traynor discussed,

The eurozone and the International Monetary Fund are engaged in a dangerous game of brinkmanship over how to respond to a Greek bailout that is going off the rails. 

It is now clear that Athens is highly unlikely to achieve the key IMF benchmark on the rescue of getting its national debt down to a "sustainable" 120% of gross domestic product by 2020.

The IMF came to this conclusion when it realized that the impact of adopting austerity in a recession for a country in a currency union resulted in a 3x greater contraction in demand than originally thought.

The word in Brussels, based on assessments from the troika of European commission, European Central Bank and IMF officials scrutinising Greece's compliance with the bailout terms, is that Athens could overshoot the sustainability target by as much as 25% on current trends, begging the question of whether the IMF will remain a party to the rescue. Figures circulating in Brussels estimate Greece's national debt will be between 130-145% of GDP by 2020 on current trends. 

The showdown between the eurozone and the IMF is being described as eyeball-to-eyeball, a shouting match, and a contest to see who will blink first. It is expected to come to a crunch next month. 

The IMF is insisting that the eurozone and the ECB resort to a new policy of Official Sector Involvement (OSI), meaning a writedown or writeoff of Greek debt to its official creditors, a move that the ECB and the German government are resisting fiercely....

Please remember that had the Swedish Model been adopted at the beginning of the financial crisis, there would be no need for the Official Sector to writedown or writeoff Greek debt.  The debt was held by the private sector, with a majority held by the banks.

It is as a result of five years of bailing out the banks that the Official Sector now has a sizable exposure.

This exposure exemplifies the pursuit of the Japanese model for handling a bank solvency led financial crisis which is designed to socialize the losses and privatize the gains.

Greece needs a bailout disbursement of more than €30bn (£24bn) next month, without which it will go bankrupt. It is certain to get the money, it is said in Brussels, since, following chancellor Angela Merkel's fraught visit to Athens this week, no one in the eurozone or in Washington wants to let Greece go bust or exit the common currency....

With a funding gap opening up in the Greek bailout trajectory of up to €30bn, the IMF is said to be arguing that the Europeans should foot the bill by writing down Greece's official debt. Other ideas being mulled over are to "extend" the €130bn bailout (Greece's second) or concoct a third rescue, all deeply unattractive options for Merkel who would need to return to an increasingly recalcitrant parliament in Berlin in an election year. 

The row comes as divisions open up in public between the IMF and eurozone leaders over the merits of austerity, after an IMF study released this week found that it had underestimated the impact that fiscal cutbacks have on economic growth. 

This study has been rebuffed by some eurozone leaders, with commissioner Olli Rehn arguing that it would be a mistake to change course. "The EU cannot be making swift turns, rather it is a convoy and you have to carefully consider which policy turns are best," he said. 

The best policy turn is to adopt the Swedish Model with both ultra transparency and the European Stability Mechanism becoming a backstop for each EU country's deposit guarantee.