Bleeding Edge

Greek restructuring would see massive losses for the European financial institutions that hold most of the country’s public debt. Yet while a pre-emptive restructuring could limit this damage, postponing will only make it worse. As both Argentina and Russia’s crisis in 1998 showed, support from the IMF does not prevent an eventual default. Indeed, it can actually cause greater damage to the country and its creditors when the former is insolvent.

When official money is used to keep a country afloat, those lucky investors whose debt claims are about to come to maturity often exit scot-free as IMF/EU support allows them to be paid in full. But when the eventual default comes, losses to the remaining creditors are more severe, because public creditors get the first slice of what remains. In short, orderly restructurings – as happened in Pakistan and Ukraine in 1999 and Uruguay in 2002 – are better for most private creditors, the debtor nation and multilateral institutions than an Argentine-style botched bail-out.

Pakistan, Ukraine and Uruguay all restructured their debt by swapping old obligations to creditors with new deals that extended for many years the time over which the countries had to pay back. These agreements also capped the interest rates on the new debt to sustainable and below-market levels. Importantly, the total face value of the debt was not reduced, as normally happens in abrupt defaults.

Of course, giving nations longer in which to pay and helping with generous rates mean creditors experience losses. But their loss is much less than under an outright default. Since the market value of their existing debt has already fallen sharply, there will be no additional mark-to-market losses either, which is part of the reason why these orderly restructurings saw the vast majority – more than 90 per cent – of creditors sign up.

Indeed, restructuring Greece’s debt should be even easier. In those three emerging market economies, public debt was issued in foreign jurisdictions – namely London and New York – creating a risk that creditors would hold out and sue to regain their assets, as sovereign immunity is limited in foreign courts. But 95 per cent of Greek debt was issued in Greece itself, where domestic sovereign immunity laws greatly reduce the risk of hold-outs and litigation.

Still, Greece is not just suffering from a liquidity crisis, because it is facing an insolvency crisis too. Rating agencies have started to downgrade its public debt to junk level, while spreads on Greek sovereign bonds last week spiked to new highs. Some people suggest that the €110bn bail-out agreed by the European Union and the International Monetary Fund in May only delays the inevitable default and risks making it disorderly when it comes and instead, a quiet and serious orderly restructuring of Greece’s public debt is needed now. I disagree.. The restructuring has commenced and it is effecting the desired results…

The austerity measures to which Greece signed up as a condition of its bail-out require a draconian fiscal adjustment of 10 per cent of gross domestic product. And this the Government is doing. Of course, this would prolong the country’s recession and still leave it with a public debt-to-GDP ratio of 148 per cent by 2016 but  ”C’est la vie.”  

Although at this level, even a small shock is likely to trigger a further debt crisis, the boat is holding well. Sharp austerity is needed – as agreed by the Group of 20 over the weekend – to stabilise debt-to-GDP ratios by 2016 in advanced economies; but for Greece such “stabilisation” even at levels that are unsustainable elsewhere, has already begun.

Another advantage is that most of the banks holding Greek debt are keeping it in their “to maturity” bucket rather than their “trading book” bucket. So long as the face value of the debt is not reduced they can still pretend – as they are doing now – that it is still worth 100 cents on the dollar when the actual market value is already lower.

The bitter pill of debt restructuring could be taken with appropriate sweeteners, such as credit enhancements supported by the IMF and EU. Certainly, it would be better to use a small amount of public money to tempt creditors into a pre-emptive deal now than waste €110bn of it trying to prevent an unavoidable restructuring later. Such public resources would be better used to help ring-fence other embattled eurozone economies – such as Spain – whose debt may come under renewed pressure.

In short, an orderly restructuring of Greece’s public debt is achievable and desirable for the debtor and its creditors. If Europe wants to avoid a deepening crisis, it is preferable too. And the quiet way of going about it seems to be a cultural shift along the gray lines of policy changes from the past crises to a new kind of crisis…

The rolling economic crisis of sovereigns…

Greece today can only be compared with Argentina in the deep 1998-2001 crisis that culminated in a most disorderly default. Argentina’s fiscal deficit at the onset was 3 per cent of GDP; Greece’s is 13.6 per cent. Argentina’s public debt was 50 per cent of GDP; Greece’s is 115 per cent and rising. Argentina had a current account deficit of 2 per cent of GDP; Greece’s is now 10 per cent. If Argentina was insolvent, Greece is insolvent to the power of two or three. On the face of it. But when You look deeper the Greek Economy can be relied upon top rally back up through it’s three pillars. Shipping, Tourism and SME Business Entrepreneurship. That has always been the bulwark of any and all assaults against the economy in the past and it will prevail again. 

Arguing that Greece can escape debt restructuring can only be supported by the narrow escape in previous sharp fiscal cutbacks made by countries such as Belgium, Ireland and Sweden in the 1990s. Such examples having occurred over longer periods and in times of economic growth they aren’t as relevant as they appear. They took place against a backdrop of falling interest rates, with depreciating currencies helping to boost growth and with national monetary policy and currency exchange levers at their control and disposal. This is certainly not the case right now… The Eurozone helps and hinders things greatly so it is possible to admit that we haven’t seen anything like Greece before.

Yours,

Pano

PS:

Still.

Nothing’s new under the Sun.

let Greece move at it’s own pace and the restructuring can be done softly and without fanfare as it has already started.

And guess what?

It can be called by any other name… too.

PS2:

Who cares what colour is your cat so long as it catches mice?