LONDON (Reuters Breakingviews) - The relief rally following last week's euro summit is well and truly over. Greece's planned referendum on the latest bailout, announced as polls show its citizens reject it, has thrown the whole pack of cards up into the air. Bank runs, disorderly default, a Greek exit from the euro and vicious contagion elsewhere no longer look like wild scenarios.
Quite what George Papandreou thought he was doing by calling a referendum is unclear. The Greek prime minister seems to have taken his European partners by surprise. The relentless criticism at home about how he has handled the crisis and the pressure from the rest of Europe for permanent monitoring of the government's actions may have caused him to snap.
Last week's planned debt restructuring and bailout isn't ideal for Greece. Even in 2020, the country's debt is still projected to be 120 percent of GDP. The people will also have to endure continuing austerity. But the package did come with the promise of 130 billion euros of new loans from Athens' European partners, of which 30 billion euros was earmarked for recapitalising the country's banks.
If the Greeks vote No in a referendum that is likely to take place in January, that aid may also disappear. Given that Athens only has enough money to pay its bills until early next year, it could then be forced into a disorderly default. The country's banks would then go bust because they hold huge sums of Greek government debt, causing the economy to plunge further into the abyss. Greece would have little choice but to quit the euro. But that would bring with it mayhem not least because Athens is still running a primary budget deficit. With nobody willing to provide it with funding, the government would have to embark on even more severe austerity.
Papandreou may hope that such a nightmare scenario will shock his fellow citizens into voting Yes. But such scare tactics could actually trigger problems before the Greeks even have a chance to vote. Depositors have been gradually taking their money out of Greek banks. Faced with the possibility of a No vote, an exit from the euro and the bankruptcy of their banks, a bank run could accelerate. As of August, there was still 189 billion euros of deposits in Greek banks. The European Central Bank would then have to decide whether to allow the central bank of Greece to continue making emergency loans to the country's banks or force their bankruptcy even before the referendum.
Contagion to the rest of the euro zone would be far more vicious than anything seen so far. Italy is the weakest point. Rome's own political shenanigans have already rattled the markets. The country's 10-year bond yields have risen to 6.2 percent, a rate that is probably not sustainable in the long run.
Last week's package came up with a plan to leverage the European Financial Stability Facility, the euro zone's bailout fund, with the idea that it would then be big enough to provide some sort of safety net for Italy if needed. The snag is that this is based on untested financial engineering, including raising money from China. After Greece's bombshell, the EFSF could face a tougher job to sell its own bonds.
Now, of course, there are other scenarios and possible contingency plans. Papandreou hasn't said what the Greek people will be asked to vote on. It is possible he will come up with a crafty question that secures a Yes vote. It's also conceivable that his government will fall before the referendum, allowing another prime minister to take over.
Meanwhile, the rest of Europe may look into their own abyss and decide that they are prepared to continue supporting Greece both through its referendum process and even after a No vote, in order to avoid a disorderly default. They may decide to regroup and force a steeper haircut on Athens' creditors in order to bring its debt load down to a more sustainable level. Finally, the ECB still hasn't turned on its big bazooka. It could theoretically stem the rot for example by itself lending to the EFSF, although this would involve swallowing all its principles.
One thing, though, is clear. Papandreou's bombshell has tipped the euro crisis back to square one - or worse.
-- Greek Prime Minister George Papandreou announced on Oct. 31 that his government will hold a referendum on Greece's new bailout package. Though the exact question to be put to the Greek people remains unclear, Papandreou said that he needed wider political backing for the measures demanded by international leaders.
-- Greek stocks plunged in early trade on Nov. 1, Greek banks fell 13.3 percent and the general Athens index was down 6.5 percent. In a sign of contagion, Italian 10-year bond yields spiked to 6.21 percent.
-- Rainer Bruederle, a leader in German Chancellor Angela Merkel's coalition government said that he was "irritated" by the news, while Alexander Stubb, Finnish minister of European affairs and foreign trade said that this would basically be a vote over their euro membership.
-- On Oct. 27, euro zone leaders agreed to a hand a Greece a second, 130 billion euro bailout with a 50 percent writedown on its debt. In an opinion poll conducted the same day, 44 percent of Greeks said the decision was negative, while a further 15 percent said that it was 'probably' negative.
-- Reuters: Greek referendum threatens new euro zone crisis [ID:nL5E7M1087]
-- For previous columns by the author, Reuters customers can click on [DIXON/]
(Editing by Pierre Briançon and David Evans)