Let us say that Greece survives the EU’s assault on democracy (Brüderle’s “It’s a strange thing to do [hold a plebiscite],” for instance), and the Greeks proceed with their referendum on whether they want the latest bailout.  Say, further, that the Greeks reject the bailout.  Now accept, arguendo, that all of the dire things EU leadership claims will happen, do happen: there is a 90% write down of Greek sovereign debt; the Greeks leave, or are dismissed from, the euro zone, and perhaps from the EU altogether; and the Greeks go back to using (a now severely devalued) drachmas.  Beyond these, some are even claiming, apocalyptically, that the future of the euro and of the EU are at stake.

What will, in fact, happen from these desperate consequences, and how might they be mitigated?

Looking at these in reverse order, it’s possible to achieve some clarity.  Greece’s economy is 3% of the EU economy, even in good times.  Greece is one small nation of 27 nations in the EU and 17 in the euro zone—the subset of the EU that actually uses the euro as their common currency.  It just isn’t that big a player.  The threat, such as it is, comes from the large holdings of Greek sovereign debt that private banks, investors, national central banks, and the European Central Bank hold—a total of some €340 billion—and the threat from this sum comes from the fact that those who hold this debt hold it as a central part of their assets.  If the debt becomes worthless, these holders’ survival—at least that of the private banks and investors—becomes problematic.  I’ll address these debt holders in a bit, but it’s clear that the failure of the EU or the euro as a result of a Greek rejection of the latest bailout—of a Greek default—is nothing more than hysteria for political purposes.

On the matter of Greece leaving the euro zone—what the hey, Greece leaves the EU—some other things become apparent.  One is the nature of the downside of Greece leaving and striking out on its own.  I see little beyond the disruption of the leaving process itself.  Greece’s Mediterranean culture and its economic principles and imperatives (large government involvement in its people’s lives, early retirement ages, vast social programs paid for with high taxes, those taxes routinely evaded, the budget deficits associated with this (even if the taxes were paid)) made Greece a poor fit with the northern European EU (with its different work ethic, smaller government and fewer social services, and lower tax rates) from the start.  This nature of this mismatch has made for a large, continuous movement of northern European private and taxpayer money into Greece in the form of those loans, in the unrealistic expectation that they actually would be paid.  Or, maybe the expectation actually was that only the stream of interest income would last long enough for a profit.  With these differences in mindset and in government and economic goals, though, the Greeks could not, and cannot, compete in the EU, and so long-term servicing of Greek sovereign debt, including final repayment, has always been a chimera.  Larger than this, it simply has been a losing proposition all along to try to force inhomogeneous economies and cultures to integrate.  The Greeks are better off on the outside, on their own, and so is the EU.  I’ll come back to how the Greeks are better off, beyond this no longer having to take part in a losing game, in a bit.

As an aside, this same set of differences, with the possible exception of tax collectability, can be said to underlie the relationship of the other major Mediterranean economies (which are, incidentally, the rest of the PIGS: Portugal, Italy, and Spain) with the EU.  And the result of this may well be the same.

Now we come to that write down of Greek debt.  First, let’s put that debt into a perspective.  The banks (private and government, including Greek banks) hold around €340 billion, as I mentioned above.  This is against an EU economy with a GDP of some €12 trillion.  The loss of those €340 billion would be disruptive, to be sure, but it’s not catastrophic.  What exacerbates the problem is the key role many of those banks play in the national and EU economies.  The EU claims that there are around 95, or so, “systemically important” banks, and the EU claims further that these must be propped up virtually at all costs because of that perceived importance.  These are the banks whose reserves are required by the terms of the present bailout proposal to be increased to 9%, an increase intended to enable the banks to handle the disruption from the 50% write down of Greek debt that this bailout envisions.  Oh, yes, one more little fillip: it’s only the private banks that must suffer the 50% loss; the governments’ banks are to be kept whole.

Now let’s look at how this might be handled.  Assuming a bailout ever is appropriate, assuming that it ever is optimal to ignore moral hazard and morality in favor of short term convenience, I offer this solution, which has the advantage of at least being a better targeted, more efficient bailout.

For simplicity’s sake, and in keeping with the back of the envelope estimating of this proposal, let’s take a worst case condition: the Greek debt is written down 100%, not 90%.  The European Stability Fund Facility, set up explicitly for a Greek (and ensuing nation) bailout, has around €234 billion left after the last round of Greek bailout, and it’s capable of borrowing to a current maximum of €440 billion.  Private banks hold around €200 billion of that Greek debt, and the governmental banks hold the remaining roughly €140 billion.  Since Brussels has said that 9% reserves is sufficient to handle the 50% write down of Greek debt, it must be so.  This leaves €100 billion of losses from a complete Greek default to be covered (again, assuming a bailout is at all appropriate).  These “systemically important” banks can be made whole, then, for just €100 billion from the EFSF piggy bank, leaving €134 billion to cover the governmental banks’ complete loss of their €140 billion holdings.  That’s rounding error, but if Brussels’ accountants get too upset, the EFSF easily can tap its debt capacity to borrow an additional €6 billion to top up the bailout.  And with the EU leadership’s views of national taxpayers, it’ll be a simple matter to adjust the national subscriptions to recover the ECB, and the nations can simply ask their taxpayers to pay a tad more for their own national banks.  This bailout is a piece of cake.  And the object lessons here will instruct the rest of the PIGS.

But what of the Greeks, now that they’re on the outside looking in?  To be sure, they’re in for tough times, but the “austerity” measures the existing and EU-proposed bailouts were putting, and are going to put, on them will create the same tough times.  Only without the EU props, now the Greeks will be forced to learn to stand on their own.  They’ll be forced, both their government and themselves, to learn to live within their means.  A cash and carry economy will teach that.  The Greeks will find it hard, as all bankrupts do, to borrow; they’ll be forced to earn their way, and success will come slowly at first, but with each success, the next will come more easily.  Over time (and in less time than will seem possible in the days after the default), the Greeks will earn their way back to respectability.  Borrowing will become possible, albeit expensively so.  With continued prompt repayment, made possible from the lessons of earning one’s own way (of necessity, since there will be no outside help available), borrowing costs will come down to a normal range.  Their newfound understanding of their responsibilities will prevent them from over-borrowing for several generations, as happens with all bankrupts, as happened with the American society after the Great Depression (whose cause was different, but the lessons of work and frugality are the same).

And Bob’s your uncle.