1 Michael Mitsopoulos Ph.D (Econ.) Boston University Theodore Pelagidis 1 University of Piraeus and London School of Economics, The European Institute, Hellenic Observatory Understanding the Greek Crisis. Unlocking the Puzzle of Greek Banks’ deteriorating performance ABSTRACT This paper focuses on the distortions that the Greek public debt has imposed on the Greek banking system and suggests how these can be unwound. The low level of competitiveness of the Greek economy, which is well below the competitiveness of the developed countries, poses a great challenge for the Greek banks. At the same time it puts at risk Greece’s economy ability to service both the private and public debt which, as an aggregate, are comparable to the indebtness of the developed nations. An adjustment of the economic activity to match the current low level of competitiveness will increase the risks faced by the financial system and make an orderly servicing of the debt of the economy very challenging. It follows that only one reasonable policy option remains: to increase the competitiveness of the economy through an aggressive reform agenda, so that it will match its level of indebtness, and through the resulting growth shift the excessive debt of the public sector to the private sector. JEL: E44, G1010, G100 Keywords: Financial Markets and the Macroeconomy, Financial Crisis, General Financial Markets, Government Bonds, the Greek Economy 1 Michael Mitsopoulos, Ph.D (Economics) Boston University. Corresponding author. 1, Paschalias str., Psychico 154 52, Attica, Greece. Tel/Fax: +30-210-6717123. E-mail: michalis@internet.gr ** Professor, University of Piraeus, 40 Karaoli & Dimitriou, Piraeus 185 32, Greece. Tel./Fax: +30- 210-7216033. Email: pelagidi@unipi.gr , t.pelagidis@lse.ac.uk . This paper has been originally written in June 2010 while Theodore Pelagidis was a senior fellow at the London School of Economics, Hellenic Observatory.