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Updated Friday, February 12, 2010 10:17 am TWN, By Mark Gilbert, Bloomberg

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Should we put lipstick on 'PIGS'?

European debt markets have been on a rollercoaster as they try to parse the EU smoke signals to judge whether Greece will win financial backing from its neighbors, or just verbal support. So far this month, the 10-year Greek yield has swung between 6.05 percent and about 6.8 percent as hopes for help waxed and waned. The euro, however, didn't exactly jump for joy at the prospect of an aid package, which tells you that a salvage operation for Greece is no panacea for what ails the common currency's economies.

Whenever the subject of the euro's conception comes up, European Central Bank President Jean-Claude Trichet can't hide a glimmer of paternal pride as he explains that one of the project's finest achievements was yield convergence — the elimination of gaps between the borrowing costs of member nations — at lower, rather than higher, levels.

In the absence of a euro-wide fiscal policy that makes spending and revenue decisions, though, there's really no reason for investors to accept the same return for lending to such economically disparate countries as Germany and Portugal, for example. You are effectively buying a foreign-currency bond because Portugal doesn't have the individual right to print currency to make its debt payments, and it can't devalue its way to prosperity.

All of this was recognized and much discussed at the euro's introduction a decade ago. Yield convergence was driven by the expectation that the rules of the euro club would impose economic discipline on its members. One possible outcome of the current crisis is for common-currency participants to cede more of their fiscal sovereignty; self-regulation hasn't worked any better in the euro area than it did in investment banking.

Some people are talking as if there's a simple choice facing European policy makers. Abandon Greece to its fate, the story goes, and unleash contagion trashing the creditworthiness of other, financially challenged euro participants. Throw a financial safety net beneath Hellenic debt, on the other hand, and you can eliminate the contagion threat.

In reality, if Greece can't solve its problems alone, the choice is between two different kinds of contagion. Why would an Irish policewoman swallow a pay cut that helps her government curb its spending if an EU handout eases the strictures demanded of Greek public-sector workers?

If economic failure goes unpunished, then behavior doesn't change — another lesson that the finance world should have learned from the credit crisis. Daubing a layer of financial lipstick on the “PIGS” makes them less, not more, attractive.

Mark Gilbert, author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable,” is the London bureau chief and a columnist for Bloomberg News. The opinions expressed are his own.

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