Mo Explains The World: What's wrong with Greece?

Last weekend I was at a friend's birthday dinner. After the requisite candle-blowing and off-key singing, we started to talk about world events. One of my friends had a simple question:

Why is Greece on fire? Are we next?

"Well," I said, "Greece's ability to service its current and future debt obligations is undergoing a crisis of confidence based on adjustments to expectation of future macroeconomic growth and its ability to maintain a sustainable level of government spending. As a result, its debt risk premium was rising accordingly, further exacerbating its annual deficits and forcing it to undergo strict austerity measures to realign its obligations with its ability to pay."

Silence. I could hear the frosting melt on the cake. This happens to me sometimes. So I took another stab:

Imagine that each of us is a different European country. Greece is the birthday boy. Compared to the rest of us, Greece seems to be in pretty good shape. He makes about $32,000 a year, mostly from his government contractor job and part-time work as a tour guide at the local museum. And like the rest of us, Greece also has some personal debts — about $37,000, most of which he's borrowed from the banks and some of it from us. That's a lot, but he can manage it if he only pays the interest, which is about 4 percent.

Unfortunately, Greece hasn't kept his spending in line. Just last year he spent $5,000 more than he earned, and now he thinks he'll rack up at least another $13,000 in debt over the next few years. So by about 2013, he'll owe $50,000. If he were using that money to go to school, start a new business, or put an addition on the Acropolis — anything that would allow him to make more money in the future — it'd be fine. But he's using that money for day-to-day expenses, like making payroll and keeping the house clean.

It's always lousy to see a friend in trouble, and it makes everyone scared about lending, period. Beyond that, Greece is a member of the European Union, which means his problems are our problems. Because we all use the Euro, and paper money is only as good as the country - or in this case, countries — that issue it, we're all on the hook for his loan. So when he moved in, his credit score became our credit score. If it doesn't look like he can handle his debt, lenders will start to wonder about the rest of us. If they don't like what they see, they can raise our interest rates. Then we're all facing a financial squeeze. Dammit, Greece!

In theory, Greece could pull himself together. He'd have to cut spending, try to earn more money, and go into serious debt-paydown mode. But his creditors aren't exactly making it easy. Once everyone learned Greece was so deeply in trouble, the banks that have been lending to Greece doubled their interest rates. They're looking out for themselves (they want to get paid for the risk they're taking), but it only makes the situation worse: At 4 percent, Greece would have paid $1,500 in interest this year. Now he'll pay $3,000, putting him even deeper into debt. It's a vicious cycle, because the higher the rates go, the harder it is for Greece to pay back his debts, which drives the rates higher.

So that's why Europe is bailing him out. If the banks won't lend him the money, we've got him — and anyone else who needs it — covered. After all, Greece isn't the only guy in the neighborhood with financial problems, and our credit is on the line, too. Plus, if Greece doesn't pay back what he owes, it could create pandemonium, if everyone freaks out and tries to collect what's owed to them by everyone else. (For a great graphic of who owes whom what, see this New York Times piece) That's not to say this is a "pass." Greece is still going to have to cut spending, and it's going to hurt. Let's just say you wouldn't want to be running for re-election in Athens any time soon.

Just to be clear, it's not bad for countries — or people — to have debt. It just has to the right amount of debt, and the right kind. If Greece had been making money faster than he was borrowing money, or using it to plan for a brighter future, no one would have blinked.