Greece defaults

By Felix Salmon
July 21, 2011
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The latest Greek bailout is done — the official statement is here — and it involves Greece going into “selective default,” which is, yes, a kind of default.

I can’t remember a major financial story which has been covered so inadequately by the financial press. All the incomprehensible eurospeak seems to have worked, along with the fact that the deal was announced in Brussels, where the general level of journalistic financial literacy is substantially lower than it is in London or New York or Frankfurt. On top of that, statements are coming from so many different directions — Eurocrats, heads of state, the Institute of International Finance, Greek officials, Portuguese and Irish officials, you name it — that it’s extremely hard to put it all together into one coherent whole.

Oh, and to complicate things even further, most of the day’s discussion was based on various widely-disseminated draft documents which differed substantially from the final statement.

This is a bail-in as well as a bail-out: while Greece is getting the €109 billion it needs to cover its fiscal deficit, both the official sector and the private sector are going to take losses on their loans to the country.

As such, it sets at least two hugely important precedents. Firstly, eurozone countries will be allowed to default on their debt. Secondly, a whole new financing architecture is being built for Greece; French president Nicolas Sarkozy called it “the beginnings of a European Monetary Fund.”

The nature of massive precedent-setting international financing deals is that they never happen only once. There’s lots of talk today that this deal is for Greece and for Greece only, but some of the more explicit language to that effect was excised from the final statement. On thing is for sure: these tools will be used again, in future. They will be used again in Greece, since this deal is not enough on its own to bring Greece into solvency; and they will be used in other countries on Europe’s periphery too, with Portugal and/or Ireland probably coming next.

As far as the public sector is concerned, the European Union will do four main things. First, it will extend the maturities on Greece’s debt from the current 7.5 years to somewhere between 15 years and 30 years: the loans that the EU is currently giving Greece aren’t designed to be repaid, in some instances, until 2041.

Second, the interest rate on those loans will be extremely low — essentially, Greece is getting those EU funds at cost, currently about 3.5%. The EU is also extending these ultra-low financing rates to Portugal and Ireland, so as not to implicitly punish countries which don’t default.

Third, the EU will put together its own stimulus plan for Greece. The phrase “Marshall Plan” was taken out of the final statement, but there’s still talk of “mobilizing EU funds” and building “a comprehensive strategy for growth and investment.” This is vague, of course, but it does at least constitute an attempt to help Greece through a period of very painful austerity.

Fourth, the Maastricht treaty will get resuscitated, with all eurozone countries except Greece, Ireland and Portugal committing to bring their deficit down to less than 3% of GDP by 2013. Paul Krugman is screaming about this, but this was a central part of the eurozone project from the get-go, and clearly the eurozone needs some kind of fiscal straitjacket for its constituent members to prevent the rest of them from running up enormous deficits and then getting bailed out by Germany.

Finally, the EU will provide “credit enhancement” for Greece’s private-sector bonds. This is a central part of the default plan, and it looks a lot like the Brady plan of the late 1980s. The official statement from the IIF, which is representing private-sector creditors in this matter, is a little vague, but essentially if you’re a holder of Greek bonds right now, you have three choices.

  1. You can do nothing, and hope that Greece pays you in full and on time.
  2. You can extend your maturities out to 30 years, and accept a modest coupon of 4.5%; in return, your principal will be guaranteed with an embedded zero-coupon bond from an impeccable triple-A-rated EU institution, probably the EFSF.
  3. You can extend your maturities out to 30 years, take a 20% haircut, and get a higher coupon of 6.42%; again, the principal is guaranteed with zero-coupon collateral.
  4. You can extend your maturities out to 15 years, take a 20% haircut, get a coupon of 5.9%, and have only a partial principal guarantee through funds held in an escrow account.

The first option is by far the most interesting. No one has come out and said that Greece is going to default on bondholders who don’t exchange their bonds; instead, there’s just a lot of arm-twisting of big banks to do all this “voluntarily.” But that won’t stop the credit rating agencies giving Greece’s bonds a default rating — this is a coercive deal, which clearly reduces the value of banks’ Greek debt. (After all, just look at those haircuts.)

Is it possible for other bondholders — those who haven’t had their arms twisted — to free-ride on the back of this deal and continue to get paid in full? I suspect that it probably is. Which is one reason why this Greek restructuring won’t be the last.

Overall, this looks like a deal which can quite easily be scaled up and used as a framework for future default/restructurings. I don’t know if that’s the intent. But there’s nothing here to reassure holders of Portuguese and Irish bonds — or even Spanish and Italian bonds, for that matter — that they’re home safe. Greece will be the first EU country to default on its debt. But I doubt it’ll be the last.

Comments
22 comments so far

“Fourth, the Maastricht treaty will get resuscitated, with all eurozone countries except Greece, Ireland and Portugal committing to bring their deficit down to less than 3% of GDP by 2013. Paul Krugman is screaming about this, but this was a central part of the eurozone project from the get-go, and clearly the eurozone needs some kind of fiscal straitjacket for its constituent members to prevent the rest of them from running up enormous deficits and then getting bailed out by Germany.”

Yes, but a straitjacket that commits to austerity in the middle of an economic slump is just about the worst thing you can possibly do.

It seems to me that a more sane way of dealing with this issue would be to enforce something along the lines of PAYGO in the US over 10-year spans.

Posted by JasonDick | Report as abusive

Out of curiosity, is there any mechanism to punish countries that breath the 3% limit (like, they don’t get access to bailout money further down the line)? Or are they just “recommitting” to things they already committed to?

Posted by jfruh | Report as abusive

For countries under programs like Greece that’s pretty easy. You don’t get a disbursement. But if those loans are on 30-year basis – it will indeed be the beginning of a European Monetary Fund (since the IMF should be out Greece in probably 5 years).

Posted by tk2 | Report as abusive

I think the Euro Zone needs to be setup like the State Govt / Federal Government system we have in the US, in which states with higher incomes subsidize the benefits of those with lower incomes.

To my (limited) knowledge, none of these debt restructurings or bonds issues change the fact that Germany is still exporting and Greece is still importing.

Germany:Greece::Texas:Alabama – yet there isn’t any sort of redistribution of incomes to make sure everyone’s happy.

Posted by djiddish98 | Report as abusive

Poll: Do you think this should have been allowed?
http://www.wepolls.com/p/1526618

Posted by crizCraig | Report as abusive

At the end of the day it is Default by Default!

Posted by Intriped | Report as abusive

Investors have ‘taken it up the tailpipe’ on their Greek holdings. Felix is absolutely right – they all know now that they will be bent over again and again on Greek holdings and those of Spain, Portugal, Ireland, Italy, et al.

As soon as this sinks in interest rates on all these bonds are going straight thru the roof as investors unload before they get sheared.

This is supposed to contain contagion????? This amounts to the giving of the contagion monkeys free passes to go anywhere and everywhere in Europe and far beyond to wreak havoc everywhere!

Welcome to the perfect storm, bozos!

Posted by NukerDoggie | Report as abusive

Interesting report. I could be wrong, but the way I read it, we will see two critical mistakes out of this plan (beyond extending Greece’s misery and prolonging the inevitable total default). One, the ECB will be printing new bills by the boatload. Two, there will be a reduction of transparency, as the EU’s antics have been exposed by the credit rating agencies beyond their comfort level.

The inflationary pressures generated by fiat money printing are going to drive down consumer spending even more radically, which means that Greece (along with the rest of the EU) cannot recover any level of real production to sustain this plan. Recapitalization of the banks is just plain stupid. They should have learned something from the U.S in that regard. The banks need to eat their peas.

As for the credit rating agencies, the EU is sore because they are being called out by one of the few relatively honest institutions in the financial world today. Those agencies got spanked first in the ’08 debacle, and they quickly compensated. The agencies’ newfound forthrightness has become an embarrassing and debilitating brake on financial voodoo by the state financial institutions, and savvy private investors will price in the risk of insufficient data when they decide which bonds to buy. Erecting a firewall against honest analysis will do nothing but deter foreign and private investment. Or at least it should.

Posted by BowMtnSpirit | Report as abusive

Excellent article Felix
I commented on it here:

http://globaleconomicanalysis.blogspot.c om/2011/07/greece-defaults-krugman-screa ms-its.html

Couple small typos in your post

It’s four choices, not three.

On[e] thing is for sure

Mish

Posted by MishGEA | Report as abusive

It still amazes me that neither the US nor the EU has (so far) resorted to high levels of inflation to clear out overhanging debt. The global system, despite failures, has turned out to be surprisingly resilient. Somehow or other it keeps bouncing back.

Think what things would be like right now with a lot of inflation. It’s not a pleasant thought, is it? Maybe we should just reserve about one second per day to be grateful for how well the basics have held together over the last 40+ years.

Posted by Ralphooo | Report as abusive

“The European Union will do four main things. First, it will extend the maturities on Greece’s debt [...]”
So far for the freedom of contract in the European Union.

Posted by IvoCerckel | Report as abusive

My Portuguese mother is still travelling way too much with her genereour public servant pension money…

Posted by Pedro07 | Report as abusive

So in essence, if I understand what Felix is trying to tell me, it means all the so-called experts in the financial markets look like dummies. They are buying stocks and the euro like all Europe’s woes have disappeared. In fact, it’s starting to get worse. Just because Europe gave Greece “a deal that won’t be repeated”. In reality, this is being done because there’s no way out and the resultant consequence would be the “PIIGS” will get slaughtered. The world is changing to “Alice in Wonderland”. WELCOME ALL.

Posted by doctorjay317 | Report as abusive

“They are buying stocks and the euro like all Europe’s woes have disappeared.”
Average deficit of EU governments: 6%. Defict of US government: 11.2%.

“So far for the freedom of contract in the European Union.”
In the EU, like almost everywhere, contracts are subject to legal requirements. And laws can be changed.

And then, when creditors reduce the burden of a debtor, can or should this be called “default”? I don’t think so. Definition of default: “failure to fulfil an obligation, especially to repay a loan or appear in a law court” But Greece fulfills the obligations that have been altered by the creditors. That’s something different.

Posted by Gray62 | Report as abusive

Felix is as usual more reasonable than his (other) American colleagues because he understands Euro Project is in principle a political project. Macroeconomics – aside – don’t trumph the EU Project and its political imperatives – kosta was es will! Germany succumbed to the political pre-requisite to bailout Greece, as an exceptional case.

Yet, the precedent has been put in place with Greece default more or less inevitable.

Bottom line, for most of you (Anglo)Eurosceptics, is rather simple – there is no way German Central Bank can stop the march towards establishing a socalled *transfer union* now that Eurobonds are formalized in the decision.

Posted by hariknaidu | Report as abusive

In 2041 Greece will be underwater, right alongside Atlantis.

Posted by plubber | Report as abusive

Is there not something of a discrepancy between the interest-rate promised on this deal Felix and the interest-rate at which the shareholders of the EFSF can actually borrow at? I saw this expressed well on twitter yesterday.

“How can Greece now pay 3.5% on 15 year borrowing from an institution (EFSF) of which a 18% shareholder Italy has to pay 5.74%. Alchemy?

How can Greece now pay 3.5% on 15 year borrowing from an institution (EFSF) of which a 12% shareholder Spain has to pay 6.11%. Alchemy?”

@notayesmansecon on twitter

As the scale of the borrowing increases these have to become more serious matters or Germany will find herself as the back stop paying a much higher rate of interest on her bunds.

Posted by Sally32 | Report as abusive

Greece has not defaulted quite yet.

There has been a new set of measures and loans announced.
There might (probably will) be temporary or selective default.

But your title is not consistent with last night’s news- its wrong and misleading.

It makes me feel like you used it as linkbait.

Posted by anastazio2 | Report as abusive

Good article and the first I have seen that asks the question about the option not shown by IIF proposal.

What happens if I – as a private citizen – holding a maturing bond decide not have a 21% write-off and do nothing. Assuming there is not another restructuring within the short term, am I compelled to take one of the IIF menu choices. I think no is the answer – hence why the CDS contracts are not triggered?

Best of luck reaching that 90% participation rate!

Posted by Caroline199 | Report as abusive

i guess europeans(who are these people?those who speak with irony for their portuguese mothers travelling too much?unless europe gets rid of this mentality that one can only get pleasure out of the death of the cow of the neighbour,there is no future in europe .not a peacefull one.because ,as history shows ,wherever there is poverty and hunger ,on one side and luxury on the other the clash is unavoidable.
nowdays with all the police forces ,the europol,the training for unconventional warfare in cities ,seems to me someone is preparing a war.and its not me.
Of course here serious people are interested in how much profit they will get out of all this.one thought :where the hell are you going to spend it if the world is a miserable place around you?you will enjoy having a drink next to some dying mothers and their kids?..i guess some would enjoy that …..thats the problem.

Posted by georgesoil | Report as abusive

If Greece defaults, it won’t be the first government to renege on its financial obligations, but its failure would set a new record, both for scale and complexity.

At the moment, the dubious honour of biggest deadbeat goes to Argentina, which failed to make good on its government debts in December 2001, to the tune of about $100 billion US.
but yes its quite important that What Will Be Outcome Of Greece Debt Crisis.

Posted by CienMichel | Report as abusive

If Greece defaults, it won’t be the first government to renege on its financial obligations, but its failure would set a new record, both for scale and complexity.

At the moment, the dubious honour of biggest deadbeat goes to Argentina, which failed to make good on its government debts in December 2001, to the tune of about $100 billion US.
but yes its quite important that What Will Be Outcome Of Greece Debt Crisis. http://www.abnglobalonline.com/what-will -be-outcome-of-greece-debt-crisis/

Posted by CienMichel | Report as abusive
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