Why is Greece still stuck after massive bailouts by the European Union? And is there a better bailout program?

Greece has made the headlines in 2012 and again in 2014/2015 for Greece's lackluster economic performance. Greece's newly elected Prime Minister Alexis Tsipras vowed to rid Greece of the shackles of austerity programs imposed by other European Union countries in 2012 as conditions for massive bailouts of 100's of billions of USD. 

Since 2012, little progress has been made in Greece's economy and ability to service the debts. The chart below shows the 5 year Credit Default Swap (CDS) prices for Greece and several other European countries. A CDS price is the premium one pays to insure $100 million. Greece is the thick yellow line. Greece's CDS prices are so much higher than the other countries that the outer most y-axis is only Greece. One can see that Greece's CDS spiked above 25,000 in 2012. Interpreting the Greek CDS price, one has to pay $25 million per year to insure $100 million of Greek sovereign bonds against default for 5 years. The Greek CDS price is much lower as of February 2015, suggesting that the current events in Europe are not expected to be as disastrous.

One can see below that Greece still has a much higher 2014 Gross Government Debt as % of GDP relative to other European and developed countries. Notice that Italy, Portugal and Ireland are close behind.

Source: IMF

However, Gross Debt only examines half of the story. Greece's 2014 Net Debt as % of GDP (chart below) is also relatively higher followed again by Portugal, Italy and Ireland. Net Debt is the difference between Gross Debt and financial assets corresponding to debt instruments. These financial assets are: monetary gold and SDRs, currency and deposits, debt securities, loans, insurance, pensions and standardized guarantee schemes, and other accounts receivable. 

Source: IMF

Greece's 2014 net government borrowings as % of GDP are also high along with and Italy's. The net borrowings are government net borrowings excluding interest payments on consolidated government liabilities. A federal budget that has primary balance equal to zero has federal revenues equaling spending but with a remaining budget deficit as a result of interest payments on past debt. 

Source: IMF

If one compares 2014 Gross Debt as % of GDP to the 2014 primary balance, or net government borrowings (chart below), one can see that Greece, Portugal and Italy are net borrowers and have high gross debt as % of GDP. Remember the primary balance excludes the interest payments on past debt, which is significant for Greece as well. This chart suggests that Greece is not on route to improve the economy but continues to dig a deeper hole.

If one examines the 5Y CDS spreads for the past year ending February 2015, one can see a fairly considerable probability of default for Italy and Spain as well. These calculations assume a 50% recovery rate (percentage of insured notional repaid in event of default). Determining the annual probability of default (PD) using the recovery rate take the CS premium say 4% and the 50% recovery rate and calculate 4%=(1-0.5)*p, where p is the probability of default, which in this example would be p=8%. 

Source: DB Research

Clearly, the Greek situation and that of Italy and Portugal are not improving despite 2 years since a major European Bailout. However, since 2012, many countries and banks have been able to reduce their exposures to Greece, perhaps limiting the possibility of contagion if Greece were to eventually exit the European Union. Greece is currently playing hardball with Germany and other European Union members but I do not see a strong hand. Germany and other EU countries are bailing Greece out with tax payer dollars, and political support for spending taxpayer dollars on Greece is likely very low.

Unfortunately, the general populace does not always understand the financial situation and are eager to vote for their own interests. Greece's citizens voted for a government that will negotiate hard - that may be good for Greece. But Greece's citizens need to understand that a world of austerity may be a better world than one were Europe runs on Greece banks and business and a exit from the European Union. If Greece fails to budge and reach a deal, then tough negotiating may lead Greece's citizens to face reductions or halts to pensions and government welfare benefits, which will hurt the poorest.

Is there an alternative to the bailout program? Well, austerity is not equal to more savings if growth slows. One can focus on saving money, but if by saving money, growth slows one can actually be poorer as a result of austerity. The bailout programs needs to favor growth in every way possible in order to believe that Greece will be able to turnaround and repay the funds.

However, the bailout program also needs to incentivize Greece to grow and to repay loans eventually. In some sense, the short term austerity measures are what provide the motivation to grow. Giving long maturity, low-interest rate debt without austerity would give Greece more flexibility, but the program does not incentivize Greece to grow since the benefits of growth eventually go to repaying other countries. Austerity is the stick that creates discontent in Greece and forces the Greek government to act today.