The Greek Tragedy Continues

The future of the Eurozone is decidedly hanging in the balance at the moment. As I said earlier in the week, the problem isn’t a simple question economics anymore: everything now is all about credibility, about who does what, and when, and how everyone else reacts. As the crisis trundles on and on, news that Greek bond spreads have hit ever higher post European Monetary Union records has become such a regular event that the process now seems almost a monotonous one. However, what happened on what we could now call this week’s Greek “Black Thursday” certainly marked a new, and more worrying milestone in the ever evolving crisis. The news this morning that Greece has demanded the activation of the EU-IMF loan – news which apparently took even the EU Commission itself by surprise it seems – only adds to the general sense of confusion that abounds.

The problem we are presented with is not only that Greek 10-year bond yields reached 8.83 per cent, their highest levels since 1998, or that the cost of insuring Greek government debt against default hit a record high of 616 basis points. The really disturbing development was that spreads on government bonds all around Europe’s periphery – including countries like Hungary and Bulgaria – widened sharply, raising heightened concerns that Greek contagion may move from being a mere possibility to becoming a reality. And the cost of protecting peripheral eurozone borrowers against default also hit record levels, with Spain and Portugal touching record highs for their Credit Default Swap prices.

The surge in Greek bonds followed news that Eurostat, the European Union’s statistical service, had revised its estimate of the country’s 2009 deficit to 13.6 per cent of gross domestic product from 12.7 per cent, and the announcement that Moody’s Ratings Agency had downgraded Greek sovereging debt to A3 from A2.

Markets are obviously nervous at the moment, and understandably so, with two issues in the forefront of their minds. In the first place the real level of commitment of core Europe, and especially Germany, to supporting the periphery through several years of difficult and painful structural adjustment is far from clear. On the other, the ability of political leaders in Greece and other affected countries to carry their citizens with them through the sacrifices which will be required to maintain the monetary system intact continues to remain in doubt.

German voters are notably uneasy about lending money to Greece, and a sizeable majority of them are against any form of aid. Reticence on the part of Angela Merkel’s coalition partner also makes obtaining parliamentary backing for the loan difficult, and the FDP senior spokesman on financial questions, Frank Schaeffler, stated bluntly this week that either Greece needed to intensify its austerity plan or it should leave the Euro.

Most observers, however, consider a Greek withdrawal to be only a remote possibility, given that any return to the Drachma would make the country’s debts even less payable. In fact the threat to the integrity of the currency union comes from an altogether different quarter. What is in now increasingly in doubt is the ability of Germany’s political leadership to carry voters with them should either Greece decide to default while continuing with Euro membership, or should other member countries be forced to apply for loans.

At the same time, some sort of Greek default is now no longer simply a theoretical possibility among many others, indeed talk of the inevitability of some form of debt restructuring (albeit voluntary) grows with every passing day. Erik Nielsen European Economist with Goldman Sachs said this week he is expecting Greece to offer some sort of “voluntary debt-restructuring” to creditors over coming months, while JP Morgan issued a research note saying that while such restructuring may not be imminent, the move would make sense given that Greece could be seen as “the sovereign analogue of a ‘bad’ company with a bad capital structure”.

Restructuring is simply a polite word for default, with the difference that it is normally carried out by agreement. The most likely form of restructuring in the present context would be debt rescheduling, whereby short and medium-term debt is converted into a long-term version, as happened with the so-called “Brady bonds” devised by the US Treasury to resolve the debt difficulties of a number of Latin American countries in the late 1980s.

One indication that the ground may be being prepared for some kind of restructuring can be found in the decision reported by German Deputy Finance Minister Joerg that any aid to Greece would come in the form of pooled loans from the euro-zone countries and not through the purchase of Greek bonds. Plans to purchase bonds are “off the table,” he said. This procedure implies that government loans would be strongly guaranteed, while private bond holders would really pay the price for the Greek “rescue”.

At the same time voices are now being raised asking whether it would not be a better idea for Germany, rather than financing more and more loans, simply to put its losses down to experience and go back to the Deutsche mark? According to Joaquin Fels, Chief Global Economist at Morgan Stanley, the Greek rescue measures could “set a bad precedent for other euro- area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time,” in this case “countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union.”

Evidently such statements can be read as bargaining postures, attempts to get politicians and voters in the South of Europe to focus their minds on the problem in hand, but they can also be read as warnings of what could happen if they do not. At the present time the situation is extraordinarily confused. Greek Prime Minister George Papandreou’s formal request for financial financial support seems to have taken almost everyone completely by surprise although it shouldn’t have, since as I reported in my earlier post the Greek Finance Minister George Papaconstantinou had previously warned that his country could call on loan backup from the EU and the IMF even while talks with the 20 strong EU, ECB and IMF mission were continuing. Actual details of the level of financial support which will be offered remain scant at this point. According to G20 sources who spoke to Reuters, the Greek government have only asked at this point for a first tranche downpayment, to give them working capital to keep going while the talks continue (think of the JP Morgan distressed company talks with the receiver analogy). What is quite striking, however, is how the government let things come to this pass before striking the decisive agreement – evidently they could not hold out till after the German regional elections, and that is another worrying sign. When all is said and done, one thing is obvious, the forthcoming loan will clearly have some kind of super-senior status (which means it would be payable before ALL other creditors – German voters would settle for nothing less), and this implies that it is likely to be existing bondholders, and not EU national governments, who are going to be invited invited to pay for the Greek bailout. How they will react to this realisation is what remains to be seen in the days and weeks to come.

This entry was posted in A Fistful Of Euros, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

14 thoughts on “The Greek Tragedy Continues

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  2. Thanks for the interesting post.

    In my view, the status of the loan is now the key question – if they would make it senior to other bond holders (thus similar to IMF loans), there would be no exit-strategy left for the public sector.

    At present, the rest of the Eurozone would finance Greece till 2012 or 2013, which presumably requires around 80 – 90 bn € (15bn € provided by the IMF). If Greece has made the heroic fiscal adjustment till then, i.e. bringing debt levels on a downward trajectory, other (private) demand for greek debt may return.

    If they make the 80 bn € senior, this exit-strategy wouldn`t work and the rest of the Eurozone would have to be involved for much longer, which would be politically unbearable.

    Am I missing something or is the whole programe doomed to fail if they make the loans senior?

    In any event, at this stage, I guess restructuring would be the best option. Although contagion and financial stability are key risks for such a scenario.

  3. Few days ago about the agreed plan “Mr Van Rompuy said “We hope that it will not have to be activated”.
    I noted at
    http://mgiannini.blogspot.com/2010/03/naked-gun-smell-of-fear.html that the fact that they hope not to activate it, it might mean that it would be a mess should it be activated.

    The loan plan was a naked gun put on the table to buy time but smelling the fer of default. It’s now clear that Greek bondholders should take a haircut and let Greece orderly default stopping the money creation for nothing of European banks.
    http://mgiannini.blogspot.com/2010/03/money-creation-for-nothing-or-let.html

  4. That’s an absolute mystery at least for me – how can the Greece been expulsed from the EUR zone, avoiding running on banks and default?

  5. well, for one thing, capital markets have very short memories. If Greece defaults, fucking over all present creditors good and hard *and* presents a credible plan to gain a primary surplus in the short/medium term, new capital will magically appear, because a Greek state that is not carrying interest payments equivalent to 5+ % of gdp on its balance sheets is a better credit risk than one that is. alternatively.. primary surplus and telling the creditors to take a hike also works.

  6. As Greece debts are too large to be repaid, there will be a default. Whether it is organized or messy remains to be seen. The Brussels reaction to the latest events – “news which apparently took even the EU Commission itself by surprise it seems ” -, while perfectly consistent with previous Eurocrats behaviour, is not exactly encouraging.

    We still hear the old canard that Greece should be saved somehow to prevent contagion to the remaining PIIGS. That is a dangerous nonsense, mainly based on faulty vocabulary. A contagion occurs when an healthy body fools around too closely with a diseased one and catches something unpleasant as a consequence. This implies that before the contagion, the healthy bodies are simply that – healthy. Well, that is not the case here. Some of the PIIGS are about as sick as Greece, but their fever has not exploded yet. No fever does not mean no disease. Disease is there and fever will come eventually, regardless of what happens to Greece.

  7. Super-senior status is basically restructuring-lite – it delays the write down but sends a clear signal: those that have the most recent and best information have demanded to put at the front of the line in the event of default.

    The EU will argue this was done just for political cover. I wonder how much time they would be buying – probably about a year or so.

    Capital markets may have short memories – but they may also delay buying anything if Greece defaults – the political and financial impacts are big unknowns. Hard to buy if you don’t know how much capital you really have.

    The problem with a hard restructuring is that it accelerates the rest of the contagion – the contraction in asset positions would be at a minimum result in some financial failures – be careful what you ask form. It is a real bind for all of the EU, not just the PIIGS.

  8. Pingback: the continuing Greek tragedy « Thought du Jour

  9. Pingback: The Greek Tragedy Continues | Greek call to activate EU-IMF loan takes EU by surprise, adds to confusion. Contagion widens spreads for other weak EU countries. Danger grows of German exit from euro « Economics Info

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  13. This is not a Greek Tragedy, this is a European Tragedy and if we are not very careful ‘austerity’ will be imposed on country after country in Europe. We have lost control of monetary policy, foreign exchange policy and now fiscal policy. Austerity policies imposed following what is essentially a Balance of Payments crisis makes no sense. What we need is regulation of international capital flows within Europe. We don’t need exporters of capital imposing their world view on everyone else. Work does not make free. Not then, not now.

    http://fxtalks.blogspot.com/2010/05/barbarians-at-gate.html#links

  14. Pingback: The Greek Tragedy Continues | afoe | A Fistful of Euros | European … | Portugal

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