Roubini on Greece

By Felix Salmon
April 28, 2010
panel -- especially when the subject is the eurozone and the possible disintegration thereof. He's been bearish on the PIGS in general and on Italy in particular for many years now, but I don't think it comes as much surprise to him or to anybody else that Greece is the first country really in the firing line.

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Nouriel Roubini, it can be safely said, gives good panel — especially when the subject is the eurozone and the possible disintegration thereof. He’s been bearish on the PIGS in general and on Italy in particular for many years now, but I don’t think it comes as much surprise to him or to anybody else that Greece is the first country really in the firing line.

One of the most interesting things about the status quo post-downgrade is that no one seems to have a clue what the base-case scenario is. Are the markets still expecting Greece to get bailed out, but adding on an ever-increasing yield premium to account for the possibility that it won’t be? Are they, like panelist James McCaughan, expecting an orderly debt restructuring later this year, with an effective haircut in the 20-40% range? They certainly don’t seem to be expecting anything worse than that — Greece’s bonds are trading at high yields, yes, but not at distressed levels, and there’s still room to lose a lot of money on those 2-year bonds if they end up defaulting.

My feeling is that the base case is one of muddling through for the next 2-3 years, with Greece scrounging up enough money from the EU and IMF to avoid a default, and Europe’s banks meanwhile staying profitable enough thanks to the ECB’s monetary policy that they build up their solvency for when the inevitable default does occur a few years down the road.

But it’s not clear that the markets are going to let that happen. It’s all well and good for the Germans and others to cover the Greek fiscal deficit for the next three years, and even to insist on tough fiscal adjustment at the same time. But if Greek yields stay anywhere near their current levels, there’s a good risk that would be politically unacceptable in both Germany and Greece. Sweden’s Bo Lundgren was also on the panel, and he helped explain how the Swedish population has the crucial and decidedly un-Greek ability to unite behind unpopular yet necessary policies once their political leaders have set a certain course. Greece, which is already seeing riots at any hint of fiscal austerity, just isn’t the kind of nation which is likely to decide that five years of wage cuts in a painful and deflationary recession is a price worth paying to stay current on the national debt.

Meanwhile, Tony Barber has already come to the conclusion that as far as Greece is concerned, “the political conditions for extra financial help from Germany just do not exist”.

Nouriel, of course, takes that kind of thinking to its logical conclusion, and kicked off the panel by announcing that it was just in time: “in a few days,” he said, “there might not be a eurozone for us to discuss.” There’s no way that Greece can implement the 10% spending cut it needs to do in order to stop its debt spiralling out of control at current interest rates — and even if it did, the economic effects would be disastrous.

Nouriel’s base case, then, is Argentina 2001: after all, Greece has a much higher debt-to-GDP ratio, much higher deficit-to-GDP ratio, and much higher current-account deficit than Argentina had back then. And if that’s the base case, there’s no way that Greek debt should be trading anywhere near its current levels.

Of course, this being Nouriel, it goes downhill from there: if Greece is worse than Argentina, he says, then Spain is worse than Greece. Its housing bubble and bust has left the banking sector much weaker than Greece’s; its unemployment situation, especially with the under-30 crowd, is much worse than Greece’s; and the cost of any Spain bailout would be so much more enormous than the cost of a Greek bailout as to be almost unthinkable. The only thing that Spain has going for it is that it isn’t quite at the edge of the abyss yet; if it gets its political act together and implements tough fiscal and structural reforms now, it can save itself. But clearly no one saw that happening, given Spain’s political history over the past 20 years.

There’s no good news here. The least bad course of action for Greece, in Nouriel’s eyes, is some kind of coercive yet orderly debt restructuring, which keeps the face value of the debt unchanged but which reduces coupons and pushes out maturities. And an exit from the euro. Alternatively, the ECB steps in and cuts interest rates so low that the euro gets pushed down towards parity with the dollar, which would accomplish something similar without nearly as much pain.

One member of the audience, though, had a really good question: what happens to the European system of sovereign guarantees of interbank lending? When those sovereign guarantees aren’t worth much any more, Euribor is likely to spike, since suddenly there’s a lot more credit risk involved in interbank lending. And there are hundreds of trillions of euros of debt contracts linked to Euribor, which could suddenly get very expensive and take control of short-term interest rates out of the hands of the ECB.

And in any case it’s worth remembering that even though Greece’s debts are small in relation to Spain’s, they’re still large in relation to, say, those of Lehman Brothers. And given that there is no formal mechanism for leaving the euro (or for defaulting on sovereign euro-denominated debt, for that matter), there will almost certainly be a range of unexpected and chaotic events somewhere down the line. That’s why I feel that although Greek bond yields are certainly going to be volatile for a while, we’re going to see higher highs and higher lows — there’s pretty much nothing, at this point, which could reassure the markets and turn Greece back into an interest-rate play rather than a credit play.

Even a massive IMF bailout, which is probably the best-case scenario for Greece right now, wouldn’t suffice to bring yields back down to their pre-crisis levels. As Nouriel pointed out, the IMF, as a preferred creditor, would make sure it was repaid, in the event of default, long before bondholders. And as a result, even if the probability of default dropped, the recovery value on Greek bonds in the event of default would drop as well. And so yields wouldn’t come down as much as you might think.

I covered emerging market sovereign bonds for many years, but I’ve never seen anything like this: a country trading at levels where the bear case is terrifying, the bull case is very hard to articulate, and everybody is talking about a possible default even when the country has an investment-grade credit rating from two agencies and is only one notch below investment grade at the third. Maybe the only thing which really explains what’s going on is that both yields and ratings are sticky. Which would imply that Greece has a long way to deteriorate from here.


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“And given that there is no formal mechanism for leaving the euro (or for defaulting on sovereign euro-denominated debt, for that matter)”

Does default need a formal mechanism? I thought it involved not paying. What formal mechanism is needed not to do something?

Posted by NemoP | Report as abusive

What’s the advantage to Greece of leaving the euro? It seems as though that would make it harder to pay back the euro-denominated debt. Could Greece try to have a somewhat orderly default while remaining in the euro?

Posted by AlexS | Report as abusive

Greece should default and then leave the Euro-zone and swap the EUR-denominated debt for “New Drachma” denominated debt at .22/EUR with longer maturities and lower coupons. This is what Argentina did and there has been very little downside for them. It would be wildly popular.

Posted by Gennitydo | Report as abusive

Default is the best of very bad options; it does not have to mean exit from the Euro; However, default would create a standstill option–allowing time to restructure debt. The problem for Greece has been its inability to act–either to simply go to the IMF and get the good (low interest rates, enough funds, expert advice on debt) with the bad (costly borrowing in the future & IMF diktat). Instead, it has the worst of getting help through the never decide Eurozone institutions, including IMF.

No one has mentioned flows of fund from Hedge Funds but I believe they are big players at the margin of speculation against the Euro per se. Bringing down the Euro is a big prize and I think the circumstances make it entirely possible, with the tacit consent of the German government.

Posted by Cesira | Report as abusive

Very few people in Europe take the S&P ratings seriously. These are the same people who gave junk mortgage bundles a triple A rating. And now they rate a sovereign nation’s bonds as junk? Greece won’t be thrown to the wolves by its Euro partners but it does have an uphill climb to get its house in order. The Euro is bigger than the sum of its parts. Unity of purpose will see off the doubters.

Posted by Hewson | Report as abusive

The Euro zone is unlikely to disintegrate because all its members have so much to lose in case it does.
However, turbulence and problems are ahead for sure, and anyone who thought we’re out of this recession may want to do some more thinking.

Side note: Where’s that Russian expert who sometime around the beginning of the recession predicted the disintegration of the USA?
If I remember correctly, he foresaw that New England would secede and join the EU, and Alaska would secede and join the Russian Federation… LOL

Posted by yr2009 | Report as abusive

There is one big thing that the EU should do immediately. The EU should impose direct federal taxes and take over the function of providing deposit insurance on a uniform EU-wide basis, along with uniform bank regulation and supervision. This will prevent runs on banks of insolvent states.

Posted by Andrewp111 | Report as abusive


You write: “there are hundreds of trillions of euros of debt contracts linked to Euribor”

Did you mean Billions rather than trillions? The entire eurozone GDP is in the ballpark of 30 trillion per anum. I’m reasonably sure there is less than 100 trillion of euro denominated debt outstanding.

Outstanding coverage of Greece and Goldman by the way… it’s amazing that well respected blogs now run circles around “mainstream” media. (Though in my opnion blogs are more mainstream than newsprint these days)

Keep up the great coverage!

Posted by y2kurtus | Report as abusive

Given the magnitude and complexity of the problem using
Occhams razor would be appropriate. The simplest solution
which accounts for 70 percent of the effects would be to
devalue the euro to 1.30. There IS no sound way to accept
slower or no growth in the Euro zone countries and the
sharing of pain would be across the board in a more or less equivalent fashion.

Posted by Kaleo | Report as abusive

These knee-jerk reactions really irritate me. The US, Japan, Greece and possibly Portugal and Spain is in trouble. That leaves 190 other countries that are starting to panick like hell, while meantime back at the ranch, some other obscure dealings are going on that will surface in 3 year’s time. Sell gold reserves off !

Posted by Ghandiolfini | Report as abusive

“There is no means of avoiding a financial collapse of a boom brought about by a credit expansion. The alternative is only whether the crisis should come about sooner as a result of a voluntary abondonment of further credit expansion or later as a final and total catastrophe fo the currency system involved.”
-Ludwig von Mises, Austian Economist
Greece could be the first “domino” in a succession of failures that will create a disasterous financial tsunami from Europe to the US. The Global situation in the “West” is completely unsustainable.

Posted by hbwaterman | Report as abusive

I don’t understand why Roubini is concerned about Italy, when it is one of the better performing national economies in Europe.

In 2009 Italy had one of the lowest defit of around 5%, second only to Germany with about 3.5%. Other countries like Spain at around 15 %, UK at 13 %, France at around 9%. Its national debt accumulated in the 70s is high, but this year surpassed by Germany’s national debts in absolute value. However, Italy’s debt in percentage to their GDP is over 100%, where Germany’s is at around 80% of GDP. Italy’s unemployment has been in the 7% region, where as Spain at 20%, France at 10%, Germany about 10%.

Posted by Sprintgt | Report as abusive

Not to worry, once Goldman is sorted out, the U.S. will be bailing out Greece. Remember the Azores.

Posted by alan10 | Report as abusive

The trillions figure was right–the number has nothing to do with the size of the economies involved, but also involves a variety of highly leveraged derivative contracts (credit default swaps, interest rate swaps, etc). Greece manipulated its deficit numbers back in 2002, or they couldn’t have met the requirements for joining the Eurozone, and have consistently manipulated them since then. As anyone who has spent much time in Greece will tell you, it is a very beautiful country with an economy built on patronage positions, in and out of government. Those are in jeopardy with the economic reforms demanded, and are not going to happen. You have already seem the response from the public service unions–and they are only just getting going. Greece has little industrial production and depends heavily on tourism. I can tell you that travel from the U.S. became much more expensive when they went to the Euro. Leaving the Euro would have the advantage that they could inflate their way out of the problem as England and the U.S. are doing. But that can only happen when you have control over your own currency–something Roubini has argued for years (correctly, I think). The Argentina solution would be fine if Greece didn’t need to go to the credit markets, hat in hand, on into the future.

Posted by ggadams | Report as abusive

Let’s get to the bottom line. Greece is a total welfare state and no one wants to produce. Until they ditch their dead-end social welfare handouts, the situation will never change.

Posted by Mitchskan | Report as abusive

The Goldman situation is going to run along site Greece and well the comment above about getting rid of the welfare handouts in Greece is a reality.

I just was not certain if they were referring to Greece or our newest US Democratic Presidential welfare state push which is just starting to crumble.

Posted by EKirkhuff | Report as abusive

When money is created out of nothing but thin air it has no real value. It isn’t backed by goods or gold,just debt It is just pixels on a screen. The only people worried out this are the people with pixel money. The rest of us poor folks will muddle through whatever happens. I’d like to see the entire house of cards collapse and have the vapor money billionaires join the ranks of the working poor.
Aimlow Joe

Posted by rcheeseman | Report as abusive

You are right, debt is relative.

The only one who has an ‘effective haircut’ around here is James Saft.

Rating agencies should be put on the red carpet for antitrust practices and not played off against each other. Who owns these guys ?

Posted by Ghandiolfini | Report as abusive

The euro is toast. If Greece had the Drachma, this problem would be local

Posted by STORYBURNcom_0 | Report as abusive

If only they’d taken a leaf out of Goldman’s parchment and insured themselves with AIG, the Greeks could be bathing naked in hot tubs full of Eurodollars.

Posted by HBC | Report as abusive

Well said, Felix.

Posted by DavidMerkel | Report as abusive

Why do we run deficits AT ALL? Don’t we have some of the best-educated workers, and (at least in Northern and Eastern Europe) some of the most flexible and hardest-working?

Don’t we have great natural resources here? North Sea oil and gas… Good quality coal and metal ores…

Why on EARTH are we running at a DEFICIT?

Posted by compsci | Report as abusive