Greek rescue: pig in a poke

July 26, 2011

By Hugo Dixon
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A deal was better than a disaster. But last week’s planned rescue of Greece has the astonishing by-product of increasing its debts. It also lets private creditors off lightly while making taxpayers elsewhere in the euro zone pay through the nose. It doesn’t even mark the end of the crisis.

True, the sustainability of the Hellenic Republic’s debt has been improved. Its government will receive 109 billion euros of new 15-30 year loans from the euro zone at an interest rate of only 3.5 percent. Private-sector creditors will also swap or roll over 135 billion euros of existing bonds into new longer-term instruments.

But this private-sector involvement comes at a huge cost. Because the European Central Bank put the fear of God into politicians about the consequences of a Greek default, private creditors have been handled with kid gloves. Sure, they are going to suffer 21 percent losses compared to the face value of their bonds (assuming a 9 percent discount rate). But that’s much less than the 50 percent haircut that is needed to put Greece’s finances onto a stable footing.

What’s more, the financial fiddling used to corral the creditors actually means Greece’s debt will rise. This is mainly because Athens will need to borrow 35 billion euros to buy collateral to partially guarantee the new bonds it will give its creditors.

The deal also envisages Greece borrowing 20 billion euros to buy back debt with a face value of 32.6 billion euros. The price, equivalent to 61.4 percent of face value, is another sweetheart deal for the creditors. A more muscular approach would have cut them to half face value.

Taxpayers in other euro zone countries, by contrast, are digging deep. Imagine they applied the same 9 percent discount rate that private creditors think is appropriate. Their new 109 billion euros of loans would be worth only 54 billion euros, according to a Breakingviews analysis. In other words, they are the ones taking a 50 percent haircut.

Taxpayers elsewhere might chip in, too, if the International Monetary Fund makes a contribution. But it would be surprising to see the Washington-based institution pay a third of the total bill as it did with Athens’ first bailout. Non-European countries, even the United States, are balking at the amount of money the institution is pouring into Greece.

Two factors could tilt the deal back in favor of the taxpayers and away from the private-sector creditors. First, the euro zone leaders hinted in their communiqué that Greece might be asked to give them collateral too. As well as providing taxpayers with protection, the collateral would give Greece an added incentive not to veer off its economic fitness regime. Given the length of the program and the fact that the Greek opposition has refused to buy into it, there is a sizeable risk Greece could stray.

Second, private-sector creditors will still be on the hook for 150 billion euros – or 115 billion euros once the collateral is subtracted. This means that, if and when it becomes apparent that Athens can’t bear its debts, it will be possible to give them another, more severe, haircut.

But even if these mitigating factors kick in, the deal is very much a second-best option. It would have been better to have done a full restructuring of Greece’s debts now. A forcible swap of all the private sector’s bond holdings, currently around 200 billion euros, at 50 percent of face value would have cut the need for new official funding to Greece to virtually zero.

In the Middle Ages, a common scam was to sell a cat in a bag while pretending it was a far more valuable pig. Buyers who didn’t look inside the bag first were conned. In those days, the word for bag was “poke”. Taxpayers outside Greece are being sold a pig in a poke.

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