Why Greece won’t go Argentine

By Felix Salmon
April 10, 2010
Bronte Capital sent me a pushback note in response to my post on Greece this morning:

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John Hempton of Bronte Capital sent me a pushback note in response to my post on Greece this morning:

I do not understand. If you are going to default (and Greece is) you get all the credit rating stuff up etc – all the pain of default.

Why not try to maximize the benefits by defaulting REALLY PROPERLY. That is actually doing an Argentina. You stuff your credit rating anyway. Nobody will lend to you.

Promise not to pay ANYTHING back – maybe 10c in the dollar and then keep that promise to rebuild your rating.

Its like when you lose the house you might as well live in it for six months free before they kick you out. No point defaulting by halves.

Flatly I think you are wrong. Argentina is the right word as far as capital markets are concerned.

He’s in good company: Peter Boone and Simon Johnson actually think that Greece is in worse shape than Argentina was pre-default.

Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment…

The odds, for Greece, are slim. It is impossible to say exactly what the odds are, but suffice it to say, Greece’s external debt and current fiscal difficulties, while tied into a fixed exchange rate regime, mean that nation needs far harsher adjustments than any of the sovereign major defaulters of the last 50 years. We cannot think of one comparable example of success. The social and political divisions in Greece, along with the penchant for debilitating strikes, also reduce the odds for success.

Boone and Johnson reckon that if Greece opted to default on its debt while staying in the euro, it would “call a stop to all interest and principal for, say, two years”, and then drive a hard bargain:

Financial collapse would mean Greek debt would need to be written down substantially. We would guess that a 65% write down of face value, bringing total Greek debt to around 50-60% of a lower new GDP, would be reasonable. Such write downs roughly match the terms that Argentina received after its debt restructuring.

Still, I’m not convinced. There’s another option here, which I haven’t seen mentioned: rather than Argentina 2001, why not go Uruguay 2002? Or at least somewhere in the middle, like Ecuador 1999? Given the choice — and of course they have the choice — I think that pretty much all politicians in Europe, including the Greeks, would opt to avoid the Argentine precedent.

There are a few different points to bear in mind here, but the first is that holders of Greek debt are powerful voters. Remember Warren Buffett’s words of wisdom:

Let’s go back to 1975 when New York City was on the edge of bankruptcy. At the time its bonds – virtually all uninsured – were heavily held by the city’s wealthier residents as well as by New York banks and other institutions. These local bondholders deeply desired to solve the city’s fiscal problems. So before long, concessions and cooperation from a host of involved constituencies produced a solution. Without one, it was apparent to all that New York’s citizens and businesses would have experienced widespread and severe financial losses from their bond holdings.

Replace “New York” with “Greece” and I think you see a plan much along the lines of Argentina’s much-maligned “megaswap” — the failed attempt to restructure the country’s debt which preceded the outright default. No principal reduction, but lots of pushing out of maturities and interest-rate grace periods, all with the intention of giving the country a bit of time to get back onto its fiscal feet. And while Greek politics are certainly dysfunctional, they’re not as dysfunctional as Argentine politics were at the time of the megaswap, and Greece’s politicians — at least the present ones — are likely to be able to avoid the kind of self-sabotaging comments which turned the Argentine deal into a fiasco. And Buffett’s point is that substantially all of Greece’s elite — not to mention most of its foreign lenders — would be pulling in the same direction if such a thing were tried: they all would know that the alternative would be far worse.

Even then, however, the alternative is not an Argentina-style default. The Kirchners have been masters at demonizing foreign lenders for short-term domestic political gain, but it’s going to be very hard for Greek politicians to do likewise. No one’s blaming Greece’s bondholders for the country’s current fiscal woes.

Argentina, to this day, is essentially an outcast on the international capital markets, and not only because any attempt to issue new debt would immediately be pounced on by the holders of $20 billion in defaulted bonds. A second swap is expected some time this month, which will help, but we’re now almost a decade on from the default, which is an insanely long amount of time to get around to dealing with the bonds you defaulted on.

Argentina therefore spent pretty much all of the oughts in a state of financial isolation: it always had to be super-careful not to place any sovereign assets abroad, lest they be attached; it could borrow only under its own domestic law; and even its own exporters frequently ran into large taxes and other obstacles to growth. It was a set of policies which might work for a proud nation at the tip of South America, but which could never work for a member of the European Union. That kind of default wouldn’t just mean leaving the euro; it would also mean leaving the EU. Which is something all Greeks would oppose, if only on the grounds that the Turks would love it.

The alternative is to have a sensible conversation with the sensible end of your creditor base — the banks and large institutional investors who understand the mathematics of debt sustainability and who want to make sure that if you default, you’re only going to do it once. When Ecuador defaulted in 1999, its creditors weren’t happy. But they could see why the default was fiscally necessary, and they overwhelmingly accepted a 30% haircut, which in hindsight was more than enough to make the country’s debt burden sustainable over the long term. (The fact that Ecuador went on to default a second time was entirely a function of politics and willingness to pay: it certainly had the ability to pay.)

Hempton is I think wrong when he says that a country’s credit rating will be “stuffed anyway” in the event of a default. If done elegantly, that’s not true at all: indeed, a successful restructuring can visibly improve a country’s balance sheet and its ratings. And Greece cares very, very, very much about being a high-income EU country and not an emerging-market basketcase. Remember that it’s still investment-grade today, from all three ratings agencies, despite its 114% debt-to-GDP ratio and 13%-of-GDP 2009 deficit. If it can use a reasonably creditor-friendly debt restructuring to get those numbers moving in the right direction, there’s no reason its credit rating shouldn’t improve.

Uruguay is a case study in how a country can default in an elegant manner, use financing from multilaterals to get it over a short-term hump, and then refinance that debt in the public markets as liquidity and positive sentiment returns.

Essentially, Greece faces two options. It can go the Argentina route, and become an emerging-market country which can support a debt level of no more than 50% or 60% of GDP. Or it can attempt to structure a solution in which it retains its status as a fully-fledged member of the EU and the eurozone, with commensurately low borrowing rates and the ability to support debt much closer to 90% or 100% of GDP.

My base-case expectation for any Greek default, then, will be a restructuring proposal offered with the full support of the EU and the IMF — including lots of liquidity from those two sources. It’ll involve a relatively modest NPV haircut of about 25%, and will probably involve no principal reduction at all — that way banks which don’t mark to market and who have Greek debt on their books won’t need to take a write-down.

The restructuring, if it happens, will be painful and noisy, of course: all defaults are. And Simon Johnson will hate it, saying that it’s insufficient and that Greece will have to reprise the whole operation all over again sooner or later. (Simon is like most present and former IMF staffers in that he loves imposing as much pain as possible on private creditors, since that means that the Fund needs to cough up less cash.) But the point is that it won’t be Argentina, and there will at least be a sliver of a chance that the other PIGS dominoes might not fall as a result.


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