The latest round of fretting in global debt markets is focused on Greece (WSJ; Greece). This is misplaced.

To be sure, there will be a great deal of shouting before the matter is formally resolved, but the Abu DhabiDubai affair shows you just where Greece is heading. The global funding environment (thanks to Mr. Bernanke, Time’s Person of the Year) will remain easy for the foreseeable future. This makes it very easy and appealing for a deep pocketed friend and ally (Abu Dhabi; the eurozone) to provide a financial lifeline as appropriate (a loan; continued access to the “repo window” at the European Central Bank, ECB).

Of course, there will be some conditions--and in this regard the Europeans have a big advantage: the Germans.

Everyone knows the German authorities are tough and hate bailouts (aside: except for their own undercapitalized banks). And the Germans can punish the Greeks with hostile bluster that the bond markets will take seriously--further pushing up Greek bond yields and credit default swap (CDS) spreads.

But, in reality, there are many voices at the ECB table and most of them are inclined to give Greece a deal--put in place a plausible “medium-term framework” and we’ll let your banks roll over their borrowing at the ECB, even if Greek government debt (i.e., their collateral) is downgraded below the supposedly minimum level.

So Greece has a carrot and a stick--and refinancing its debt is so cheap in today’s Bernanke-world, they will not miss the opportunity. 

Greece has become a quasi-sovereign, in the sense that it issues debt not in its own currency. But it still has control over its own cash flow. And most budget math is based on perceptions of plausible baselines that are--in case you didn’t already know--more about political perceptions (in this case, within the ECB governing council and perhaps EcoFin) than likely economic futures.

The important development is the role of the European Central Bank. It is becoming a de facto International Monetary Fund (IMF), but just for the eurozone (or is that the European Union?). It will lend a troubled country money, but only if the government does some of the hard fiscal work. The IMF may have a role to play in budget advice and assessment for Greece, but it may also be squeezed out of a meaningful policy role.

This is good, in the sense that there is no stigma attached to having your banks borrow from the ECB. When random bad shocks hit, it’s good to have a safety net that countries are willing to use.

But this is also less good, in the sense that as the global economy moves back towards boom times, putting more bailout mechanisms in place and removing even further the downside risks for creditors is--in the broadest possible terms--asking for trouble. Why worry about whether borrowers can repay if there is a deep-pocketed sovereign (run by a cousin, neighbor, or committed friend) who will, when push comes to shove, protect all creditors?

[Cross-posted from The Baseline Scenario.]

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