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business newsWhy Greek Default Is Inevitable
By
Matthew Mallon
Apr 19, 2011 9:50 am
With its austerity program foundering even in the face of a new round of harsh cuts, the country is well and truly on the rocks.
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Such words from such a senior German – even though Schäuble couched them in the softest way possible, hinting at a voluntary, internally arranged restructuring at some vague future point – sent the market into an immediate tizzy, with bond yields soaring once again, two-year Greek bonds spiking at a whopping 18.30%.
Spain, the domino no one wants to see fall, the economy that had supposedly been successfully “decoupled” from the eurozone’s sovereign debt crisis after the Portuguese bail-out, saw spreads on 10-year bonds widen by 14 basis points.
Schäuble quickly attempted to backtrack, claiming he hadn’t been talking about an actual restructuring at all, but over the weekend further reports emerged that the Germans were preparing contingency plans for Greek debt restructuring.
As usual, Greek and EU leaders lined up to deny that any such restructuring was in the works. It’s the polite, political thing to do, especially as restive German voters and other domestic audiences across the continent don’t want to hear about Greeks being cut further deals.
But the bare facts tell a different story. With its austerity program foundering even in the face of a new round of harsh cuts, with an inability to attack root issues such as the country’s huge underground economy (estimated to be worth at least a quarter of its official GDP), with increasing domestic volatility and social unrest, not to mention a shrinking official economic outlook (4% contraction this year, with 2% optimistically predicted for the next), the country is well and truly on the rocks.
Last spring’s hasty EU/IMF bail-out may have staved off immediate financial collapse, but has done little else other than delay an unpleasant reckoning while adding billions to the country’s debt load, which will hit a crushing 160% of GDP by 2013. Borrowing costs, already stratospheric, went even higher after Schäuble’s comments. Add in inflationary pressure, tightening European Central Bank policies and the similarly strained pocketbooks of its neighboring trade partners, and a default seems inescapable.
When? Not immediately. Internal EU reports on the situation are due in June, and it’s unlikely anything will happen before then. As per previous policy, eurozone officials seem to be interested in waiting until the last possible moment, preferring to cross fingers and suffer the strain of ongoing market tensions rather than take definitive action and risk a catastrophic reaction.
So: A Greek default is, barring a miracle, on its way, 2013-ish. The big question: What kind of default? Greek debt-holders range from troubled domestic Greek banks (estimated to be carrying at least 20% of the burden) to the largest German and French financial institutions, and all are vulnerable to serious blowback if the default panics the market. Some analysts estimate Greece will need to impose losses of anywhere from 50 to 70% -- a level of loss that, handled poorly, could throw the entire region into a tailspin.
The Germans, de facto eurozone rulers, are so far keeping the wraps on their own restructuring plan, but as mentioned above, have hinted at something less draconian than a involuntary, across-the-board bondholder haircut. There are many possible options on offer: Lee Buchheit, an American lawyer who advised Uruguay on its successful default in 2003, suggested last week at a Florence conference that a Uruguayan-style “voluntary” agreement, in which creditors are persuaded to accept extensions on their contracts, along with the offer of credit enhancements such as the creation of European “Brady bonds” – in essence, EU-backed T-bills – might be a palatable solution. Even then, he warned, a haircut of some sort would be still be in order. "Will it just be the first of a two stage restructuring with the real blood-letting deferred to stage two?" Buchheit asked the conference.
Deferred blood-letting sounds like the EU’s preferred modus operandi, but the longer the chatter about a future Greek default goes on, the higher the tension in the region. Nervous investors, expecting pain in 2013, will continue to ratchet up the price of Greek debt, as well as that of Ireland and Portugal. The contagion could easily spread again to Spain, Italy or Belgium. Meanwhile in Finland, the strong showing of an anti-euro party in recent elections shows that patience among voters in creditor nations, tested by one expensive bail-out after another, grows thin.
No positions in stocks mentioned.
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Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
