Why Europe's Debt Crisis Will Keep Coming Back

Mark your calender: These events could roil markets over and over.

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Thank God that's over. Now we won't have to worry about Greece for … a couple of months or so.

If mounting anxiety over European debt—followed by a flurry of last-minute maneuvering to avert total disaster—is starting to seem like a regular ritual, get used to it. Authorities in Athens and other European capitals seem to have forestalled Greece's insolvency once again, with new austerity measures passed by the Greek government that will allow the struggling nation to get its next installment of bailout money from European governments and the International Monetary Fund. But there could be several replays of the drama over the next several years. "I'm afraid Greece will become like Groundhog Day," says Paresh Upadhyaya of Bank of America Merrill Lynch. "It's not going to disappear."

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For those not keeping an inning-by-inning scorecard, the European debt drama began last year, when Greece became overwhelmed by its debt, nearly ran out of money, and needed a $145 billion bailout from Europe and the IMF. Greece is scheduled to get the money in quarterly installments over three years, with each payment preceded by a review to make sure the profligate borrower is cutting government spending, paying down debt, and reforming its unproductive economy so it can someday borrow again in the private markets. Greece has hit some targets but missed others, plus, overoptimistic assumptions from last year's plan have left it needing an additional $70 billion or so. The bailout barons in Europe seem likely to come up with the extra money, but they're leaving several key decisions for another day.

Debt overload in Ireland and Portugal have led to bailouts there, too, with the biggest fear being a financial panic that could occur if any of these nations actually runs out of money and defaults on its debt, much of which is held by European banks. The default scenario could trigger a cascade of losses and freeze financial markets, which is the biggest worry. While Europe's so-called peripheral countries are somewhat expendable—financially, at least—the bailout barons are trying to form a Maginot Line in front of Spain, a much bigger economy with debt problems of its own. If Spain were to require a bailout, it could overwhelm Europe's resources and trigger a Lehman-style financial meltdown.

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Critics of America's empty-rhetoric politics will be relieved—or perhaps horrified—to know that it's far worse in the euro zone, where there's no central authority, nations often have opposing interests and it's almost guaranteed that nothing gets done without a crisis. "Imagine if the National Governors Association had to pull together a bailout of Delaware," says Jacob Funk Kirkegaard of the Peterson Institute for International Economics. "If Texas and California had to come up with money for Delaware, the politics of that would be pretty messy, too." That's why the solutions to Europe's debt crisis have been partial at best, and the problem will continue to sporadically roil markets. Here are some of the developments that could trigger the next round of financial-market palpitations (or the one after that):

More backsliding in Greece. Every quarterly review of Greece's progress on economic reforms could identify problems that hold up a bailout payment and provoke a replay of the recent drama. Problems could develop right away, since Greece's powerful unions are likely to strike in several industries, to protest pay cuts, layoffs, and other tough measures imposed on workers in bloated, state-run-sectors. David Zervos of investing firm Jefferies & Co. likens those actions to the 1981 air-traffic-controllers strike in the United States, which ended up severely weakening the controllers' union. While strikes will be deeply disruptive, Zervos and others think Greece will muddle through that turbulence.

A bigger test may come toward the end of the year, as it becomes clear whether Greece is making any headway selling a huge portfolio of state-owned assets such as utilities, ports, railroads, and real estate. Greece is supposed to raise about $70 billion through privatization, but it's not clear whether buyers will materialize for assets that might remain captive to Greek unions or mired in political upheaval. "If Greece can't manage to sell several significant public companies within the next six months, I believe it will be a serious problem," says Kirkegaard. That would darken financial markets if, once again, a quarterly IMF review identified problems that threatened another bailout payment.

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Worsening problems in Ireland and Portugal. The bailout regime for these two countries is similar to that for Greece—with the same rosy assumptions about a quick return to the private debt markets, which seems unlikely any time soon. Between now and 2012, Europe and the IMF will probably have to modify the plans to fund these two countries, effectively extending more bailout aid, as they have for Greece. Neither country is quite as strapped as Greece, but the cumulative cost of the bailouts leaves less and less cushion for dealing with unexpected problems. The bailout gap in both Ireland and Portugal could become acute within six to nine months, requiring further action.

Spanish banking woes. The big worry about Spain is that regional and local banks could be sitting on an explosive amount of unacknowledged losses relating to a real-estate bust. If they are, it could require a takeover of the Spanish banking sector—and an unmanageable amount of bad debt—by the Spanish government, a scenario that's similar to what swamped Ireland. A big test of Spain's banking system should come late this summer, when there's supposed to be a public offering for a new company formed from several of Spain's regional banks. If the IPO flies, it will be a sign that investors have confidence in the banks' ability to solve their own problems. If it fails or gets delayed, it will be a sign of trouble.

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An ugly endgame. Even if Greece grudgingly does everything demanded of it over the next couple of years, there is still a good chance it will default on its debt in some way, and perhaps even leave the European Union. Many market analysts think it's inevitable that Greece will require a debt restructuring, and that recent maneuvers are simply buying time for Europe's banks to prepare, and perhaps for Ireland and Portugal to build defenses against financial contagion. If you're making your calendar, put a big red circle around the first half of 2013, which is when the three-year bailout plan is set to expire and Greece, theoretically, is supposed to be healthy enough to borrow on its own. It probably won't be. A European debt crisis is always lurking.

Twitter: @rickjnewman