When the EU strongly objected, the government pledged real reform. The job falls to Maritime Affairs Minister Haris Pamboukis. In an interview with Fortune, Pamboukis pledged to fully open the market. "The big international cruise lines are talking about starting their cruises in Greece. We're going to get rid of the restrictions on that contract and make it happen," he says. Another potential boon is a new law that for the first time effectively allows developers to build planned resort developments and sell villas to European retirees, a change that could make Greece the Florida of Europe.
Given the government's halting, uneven record on reform, it's hard to predict if the new rules will truly work. The problem is that even big steps toward genuine free trade won't produce the revenues Greece needs to service its gigantic debt, slated to reach 172% of GDP by 2012, according to the IMF. "It's impossible for Greece, or almost any country, to carry debt that big," says former IMF executive board member Miranda Xafa. Fortunately Greece can fund itself for two more years on cheap borrowing from the troika before it faces restructuring that debt. But it almost certainly has to happen -- and bondholders will need to take a substantial loss. The hope is that by then the crisis will be over, and Europe's banks can absorb the damage.
Too big to bail out
By contrast, Italy and Spain, which pose a far bigger risk to the eurozone, don't have the luxury of time. The rates on sovereign debt for Italy and Spain have recently jumped, hitting 6.3% for 10-year notes, until the ECB intervened to wrestle them back down. The relentless pressure on rates raises a double danger. First, it could cause a banking crisis by hammering the value of bonds owned by lenders. "The Italian banks have large holdings of Italian government bonds," warns economist Dadush. "If they decline enough, the banks will become even more nervous about lending, and they're already extremely nervous." Second, unlike Greece, Italy and Spain are paying part of their bills by floating new bonds, and if rates stay at over 6%, they can't possibly cover the interest on their debt. The only option would be a catastrophic default.
The challenge for Italy is the sheer size of the public debt, a staggering $2.7 trillion, the third-largest number globally, behind the U.S. and Japan. Italy has a relatively small budget deficit at around 4%. But even if rates return to near-German levels, Italy doesn't grow fast enough to keep that debt from increasing, largely because its economy is shackled by many of the same restrictions that are killing Greece.
In Spain the problem isn't the current debt load but where it's heading: Spain is saddled with a huge, 9.2% budget deficit. A housing collapse following the worst bubble in Europe severely weakened its lenders, raising fears of the need for banking bailouts. Prime Minister José Luis Rodriguez Zapatero has pledged to lower the deficit to 6% this year. He's also promising the same kinds of free-market policies that are moving forward in Italy and Greece, including reforms to the centralized wage-setting system for private companies that raises pay faster than inflation.
The brewing crisis for Italy and Spain exposes a striking weakness in the structure of the European Community. The EU lacks a lender of last resort, an institution with virtually unlimited resources to guarantee the survival of the euro. So far the ECB has been going far beyond its mandate of maintaining price stability, with the grudging assent of the Germans, to buy Italian and Spanish bonds. But the ECB is unlikely to veer from its mission for long. The fund created for the Greek bailout, the European Financial Stability Facility, is being granted new powers to buy sovereign bonds. But the EFSF, even with $620 billion at its disposal, is far too small to counteract a sustained attack on either Italian or Spanish bonds, let alone both.
It's possible that the crisis will become so severe that the EU will be forced to issue euro bonds, guaranteed by all the member nations, to cover the debt. That would place a big burden on the taxpayers of the wealthy countries, especially Germany, that pay most of the EU's costs. It's a solution that Germany dreads but may need to shoulder if the only alternative is financial Armageddon.
By far the best remedy is rapid reforms that restore the confidence of investors, a reversal of the runaway spending of the bumper years, and the long-overdue liberation of markets. That's what the EU was supposed to do at its founding. Then it lost sight of the basics while pursuing supposedly loftier goals.
Today a new breed typified by Mayor Boutaris of Thessaloniki are seizing the moment. "Believe it or not, the crisis is very helpful," says Boutaris, lighting another Camel. "We'd never even be talking about these reforms if we didn't have a near-death experience." In this land of mythic tales, it's time for some new heroes to step forward.