Over the weekend came this news from the WSJ:
French Finance Minister Christine Lagarde signaled Paris might support a rescheduling of Greek debt, warning that Greece is at risk of default if it doesn’t do more to bring its public finances into order.
The comments mark a shift in France’s position in a debate that has pitted Germany and other euro-zone governments against the European Central Bank, which opposes any form of restructuring of Greek debt.
French support for proposals to extend the maturities of Greek debt—a so-called soft restructuring—would leave the ECB isolated in its opposition and possibly force it to accept a compromise.
“What we certainly don’t want is a state bankruptcy, a default, in Europe,” Ms. Lagarde said in an interview published Friday in Austria’s Der Standard newspaper. “You can use a lot of words—reprofiling, restructuring, re-this, re-that—but what there won’t be is a restructuring of Greek debt.” At the same time, she said: “We would accept anything that is based on a voluntary accommodation by banks.”
“If the banks decided unilaterally after contacting the Greek authorities to offer a lengthening of the repayment time frame, she wouldn’t be against it,” Ms. Lagarde’s spokesman said.
Germany and other euro-area states have warmed to the idea of extending maturities—which is technically considered a default by the credit-ratings agencies—given the size of Greece’s debt burden and its bleak economic prospects.
Hmmm. That’s an understated if ever I’ve heard one. Maturity extension is default.
Anyway, there is lot’s a great discussion around the world on what the fallout will be. At the UK Telegraph, Andrew Lilico offers a chain of events that makes the word ‘contagion’ positively inviting:
- Every bank in Greece will instantly go insolvent.
- The Greek government will nationalise every bank in Greece.
- The Greek government will forbid withdrawals from Greek banks.
- To prevent Greek depositors from rioting on the streets, Argentina-2002-style … the Greek government will declare a curfew, perhaps even general martial law.
- Greece will redenominate all its debts into “New Drachmas”…
- The New Drachma will devalue by some 30-70 per cent…effectively defaulting 0n 50 per cent or more of all Greek euro-denominated debts.
- The Irish will, within a few days, walk away from the debts of its banking system.
- The Portuguese government will wait to see whether there is chaos in Greece before deciding whether to default in turn.
- A number of French and German banks will make sufficient losses that they no longer meet regulatory capital adequacy requirements.
- The European Central Bank will become insolvent, given its very high exposure to Greek government debt, and to Greek banking sector and Irish banking sector debt.
- The French and German governments will meet to decide whether (a) to recapitalise the ECB, or (b) to allow the ECB to print money to restore its solvency…
- They will recapitalise, and recapitalise their own banks, but declare an end to all bailouts.
- There will be carnage in the market for Spanish banking sector bonds, as bondholders anticipate imposed debt-equity swaps.
- This assumption will prove justified, as the Spaniards choose to over-ride the structure of current bond contracts in the Spanish banking sector, recapitalising a number of banks via debt-equity swaps.
- Bondholders will take the Spanish Banking Sector to the European Court of Human Rights…
- Attention will turn to the British banks. Then we shall see…
As over the top as this sounds, it sounds roughly right to me in the event that sorting out Europe’s imbalances is left to markets.
But this is surely not a realistic scenario. The financial links exposed by the Lehman failure are painfully obvious to policy-makers now, which is surely why they declared as a group that there’d be “no more Lehmans” and why Greece has so far lurched from one bailout to the next. In any case, at this point Lagarde seems to be testing the wind for “voluntary accommodation” from creditors, not throwing Greece to the wolves.
Yet, as Steven Pearlstein of the Washington Post points out, the Europeans are stuck:
There are several problems with this diagnosis and prescription.
The most obvious is that Greece is already caught in the early stages of a debt spiral. The austerity measures necessary to bring Greece’s government budget into balance have caused such a deep recession, and tax revenues have fallen so steeply, that the primary deficit is increasing, not decreasing. History shows that once such a dynamic gets going, it is self-reinforcing and very hard to pull out of. A similar dynamic seems to be taking hold in Ireland, Portugal and even Spain, where economies are shrinking and unemployment continues to rise to alarming levels.
…I spoke with Bill Rhodes, the former Citigroup executive who played a central role in every sovereign debt crisis of the past 30 years and who has written a book about his experiences, “Banker to the World.” Rhodes knows how to drive a hard bargain with profligate countries, but he also knows when it’s foolish to push them too hard and load them up with too much debt service. And that’s exactly what Rhodes sees happening with Greece, Ireland and Portugal.
The question isn’t whether creditors will take a haircut. The question is whether they’ll take a small one now or a big one later.
Alan Beattie at Eurointelligence has a similar line with greater subtlety:
Contrasting experiences from the neighbouring Latin American countries of Argentina and Uruguay in the early 2000s suggest that a one-off voluntary deal can help a country if it is faced with a genuine liquidity crisis, but if it has to be followed by more fundamental restructuring it can end up doing more harm than good.
The happy outcome was Uruguay which, appropriately enough, suffered a massive withdrawal of Argentine deposits from its banking system as the Argentine government slid towards sovereign bankruptcy at the end of 2001, and from a general increase in risk premia on Latin American assets. Uruguay’s 2003 sovereign debt restructuring, accompanied by an IMF rescue programme, was closer to a reprofiling. It extended maturities on all sovereign debt denominated in foreign currency, then equivalent to about half the total, but led to a reduction of only about 8 per cent in the net present value. The offer achieved more than 90 per cent acceptance rate, and together with tough but not quixotic fiscal restraint – a primary fiscal surplus of around 3 per cent – Uruguay restored favourable debt dynamics and avoided further default.
The cautionary tale was Argentina, one of whose most egregious mistakes in the run-up to bankruptcy was the voluntary bond “megaswap” of June 2001. The swap rescheduled about $30bn of sovereign debt, smoothing the big hump of interest and principal payments coming due in the next few years to beyond 2005. But in order to be voluntary given the state of the economy, the terms had to be sufficiently generous with the consequence that the net present value of the exchanged part of Argentina’s debt stock rose by 28 per cent. The only effect it had – apart from earning nearly $100m in fees for the investment banks that arranged it – was to enlarge the stock that had to be restructured when the inevitable came.
… The lessons should be obvious. Voluntary swaps can work, but only in a liquidity crisis. Uruguay, despite some underlying problems in its banking sector which were exposed by the crisis, had reasonable growth performance and political commitment to economic reform. In an insolvency crisis such as Argentina, they are likely to make things worse.
Given that Greece appears insolvent under all but the most optimistic growth and revenue assumptions, the Latin American experience of the 2000s would argue against a voluntary reprofiling in favour of a more substantial reduction in NPV.
One hopes that ultimately this ends in some new European fiscal integration or in a collective mechanism for refinancing the banks that stand to take the losses. But the parallels with 2008 and Lehman brothers are really quite uncomfortable. We have a solvency crisis based around a debt deflation being treated as a liquidity issue. Bond rates that have rocketed to impossible levels on expectation of default. Politics at odds with regulators on what to do. Ideals at odds with practicality. And behind it all a European and global banking system that is so interlinked, doing the right thing may prove calamitous.
And there is definitely a sense that only crisis will push the Europeans to finally find an integrated solution.
On that, I’ll leave you with a quote from Doug Noland over the weekend:
And the backdrop really turns uncertain when one ponders a repeat of last year’s scenario where Greek debt problems turn systemic through a dislocation in the CDS market. And if, once again, such a development leads to euro weakness, the resulting boost to the dollar could further catch players on the wrong side of various “carry trades” and other bets gone astray. As I noted above, the end of QE2 doesn’t have to mean liquidity issues for the marketplace. Then again, the end of quantitative easing becomes a major market liquidity event if the marketplace is in the midst of a serious bout of speculative de-risking and de-leveraging. Much to contemplate and analyze over the coming days and weeks.
