‘Greek misery’, ‘Hellenic precipice’ or unwelcome comparisons with Dubai and Iceland, who both cannot repay their debts. Truly, the headlines about Greece since the start of the New Year could hardly be more telling. They are similar to a Greek tragedy. However, the final act has yet to be completed in Athens.

The macro and microeconomic indicators for 2009 speak volumes. The budget deficit reached 12.7 percent of GDP. Registered unemployment was above nine percent, and youth unemployment surpassed 20 percent. Public sector debt corresponded to more than 125 percent of annual GDP. International credit rating agencies downgraded Greece’s sovereign credit rating and added a negative outlook. More than 10.000 shops closed during the past year. Tourism declined and shipbuilding suffered heavily from the global economic crisis. In a word, the Greek economy is ‘dying a slow death’ as the credit rating agency Moody’s observed.

The severity of the situation and magnitude of the challenge is further exemplified by a look at the recent development of interest rates that Greek authorities have to pay for the issuance of short-term sovereign government bonds. In auctions carried out in the third week of January 2010 the government was able to sell three-month bonds totaling €3.8 billion with a coupon of 1.67 percent. By contrast, more than three months earlier after assuming office in the second week of October 2009 the new Papandreou government auctioned short-term bonds totaling €7 billion in volume, but at a price of 0.35 percent.

This significant shift in volume and pricing levels implies that the Greek government is currently in a position where it can only sell less sovereign debt at ever higher prices. More specifically, the Greek government’s refinancing needs during the first half of 2010 may be achievable. However, this comes at an ever-higher price that will have to be paid.

Short-dated Greek bond yields are currently trading at colossal premiums to those in several central and eastern European countries classified as emerging markets. The risk premium priced into Greek yields is unsustainably high for the government to continue borrowing at these levels in the medium-term. Mounting worries about the country’s fiscal position and capacity to refinance it are contributing to these yield levels.

The depth of the current crisis has revealed how paper-thin the image of the robust, growth-driven Greek economy was during the past decade. It is now becoming increasingly clear that Greece’s ‘economic miracle’ – as it was repeatedly termed by its political advocates – was based on a ballooning public deficit and a mentality of ‘buy now – pay later’.

Many citizens and observers are now asking themselves, where has all the money gone? To illustrate, in 2006 public expenditure reached 42,9 percent of annual GDP. In 2009, only three years later, public expenditure had risen to 52 percent of annual GDP, while tax revenue remained at the same level as in 2006. In other words, the difference in expenditure levels relative to annual GDP corresponds to a 9.1 percent increase within three years! In absolute monetary terms this increase totals approximately €23 billion.

This amount corresponds to the budget deficit in 2009 and constitutes roughly 45 percent of the government’s borrowing needs in 2010, which are said to be around €53 billion. Put otherwise, if public expenditure had remained at the level of 2006 today’s governing authorities would not have to confront the dire economic problems and budgetary challenges of 2010.

Meanwhile, the Greek finance ministry insists that the country would be able to satisfy its borrowing needs during the first half of 2010 and ride out the fiscal storm. However, investors and bond traders continue to appear skeptical as the spread of the 10-year Greek government bond yield over its German counterpart hit 312 basis points on 21 January 2010. The spread difference was the widest since Greece adopted the euro in 2001. The cost of insuring Greek sovereign debt against default reached a fresh record high of 358.7 basis points on the same day.

For many commentators and anxious citizens the key question is if Greece will be able to avoid bankruptcy, i.e. default on its sovereign debt obligations? Some speculators are clearly hedging their bets, while contingency scenarios are being considered in Brussels, Frankfurt and London. Meanwhile, in Athens, Thessaloniki and across the Greek isles coffee-shop talk focuses on finger-pointing, conspiracy theories, and how best to avoid addressing collective responsibilities.

Amid this popular discontent and anxiety there appears to be one common thread of reasoning, namely that the moral bankruptcy of the country has already arrived. The end of an era or the model of doing things Greek style’ has no future. Put bluntly, the Greece of yesteryear is bankrupt. What way forward then? And with whom, since many of the political and economic elites in the country are rather discredited?

Can Greek society reinvent itself? A society that has mastered the art of living in denial during the past decade. A country whose institutional geography and arenas of decision making are not geared towards consensus and compromise. A population whose mentality of rule breaking, tax evasion, underground economy and corruption has permeated most corners of daily life. It’s a long shot, and it is going to be painful. Greek society is not yet prepared for this odyssey.

The option of muddling through is not available anymore. The consequences of trying would be dire and have been set out all too clearly by the IMF in Washington, the European Central Bank (ECB) in Frankfurt and the European Commission in Brussels. Structural reforms now and a root-and-branch re-evaluation of budgetary resources are called for as the order of the day. In other words, the transformational character of this crisis is as important as individual reform steps. What does that mean in practice?

The new centre-left government of George Papandreou took office in October 2009. The momentum of its electoral victory was quickly overtaken by the urgent need to switch into crisis management mode. Given the magnitude of the challenge and the complexities that is modern-day Greece, its implementation requires time and consensus building. Throwing money at the problems is not an option anymore because the coffers are empty.

The adoption of a comprehensive reform agenda in the context of a deep economic crisis and budgetary exit routes being closed presents the Papandreou government with a sheer insurmountable challenge. The prime minister has to deliver quickly to satisfy international capital and bond markets while simultaneously heeding to the demands and expectations of the international community, i.e. the European Commission, the ECB and credit rating agencies. In order for his reform proposals to bear fruit he needs the luxury of time; a precious commodity he is not afforded at present!

Two current social conflicts serve as test cases for the capacity to adopt or reject a profound mentality change along with structural reforms. One concerns farmers’ demands for extra government funds to alleviate their economic situation. As a powerful protest tool they are blocking with their tractors transport routes in Greece and various border crossings with neighboring countries. The other example deals with ongoing negotiations within individual ministries to curtail supplementary salary benefits of public sector employees. The outcome of both these negotiations will determine the government’s capacity to set a symbolically important precedent. If successful, the message would be that cost sharing is necessary and common sacrifice possible.

Could there be further light at the end of the tunnel? Two additional policy solutions are worth considering. They may point in the direction of how to confront the challenges at hand. One concerns the issue of reduced time and narrowing alternatives. It may turn out to be an unexpected benefit that the Papandreou government has so few alternatives at hand and even less time to deliver. This restriction shapes the substance of his anti-crisis program in a manner that leaves little space for Greek-style business as usual. The magnitude of the crisis and the threat of debt Armageddon constitute an unprecedented game changer for the Greek political economy and reality check for its citizens.

The second potential solution concerns the question how systemically relevant Greece is for the euro-zone area? More specifically, at present both the European Commission in Brussels and the ECB in Frankfurt as well as a host of politicians from Berlin to Paris and Vienna have publicly ruled out any external assistance for Greece’s budgetary and debt woes.

The argument put forward focuses on legal clauses in the Maastricht Treaty and the Stability Pact. Despite such a legalistic, treaty-centered reading, one should not lose sight of the fact that until recently large-scale bailouts of financial institutions were deemed impossible and inappropriate. That is until those responsible across Europe and beyond discovered the magic solution under the heading ‘systemically relevant’. Put otherwise, hubris and hypocrisy are not scarce resources when currently debating the Greek challenge.

Seen from this perspective, the merits of legal arguments against bailing out Greece by other euro-zone members must be taken with a pinch of salt. Any intervention or refraining from doing so will be determined by political opportunity costs. While not wanting to set a precedent, and thus introduce ‘beggar-thy-neighbor’ policies, the risks of being dragged downward by Greece’s economic and budgetary calamities could ultimately outweigh legal jargon and institutional constraints.

It may thus only be a matter of time until policy makers across Europe throw out the rescue anchor towards Athens and engineer damage limitation operations. They had little hesitation to do so when rescuing financial institutions ‘too big to fail’ in 2008/09. Put provocatively, if Greece were a ‘systemically relevant’ bank, the authorities across the continent would long have found ways to save it!