The Troika vs Greece

By Felix Salmon
January 30, 2012

Are you worried about Greece failing to come to some kind of agreement with its bondholders? If so, you’re far behind the curve. Because the new big worry is that Greece will fail to come to some kind of agreement with the Troika — the official-sector entities which are going to fund its deficits for the foreseeable future.

To understand what’s going on here, you really need to read two different things. The first is the latest paper from Mitu Gulati and Jeromin Zettelmeyer, entitled “Engineering an Orderly Greek Debt Restructuring”. It’s clear, it’s clever, and it explains exactly what Greece’s options are. The second is the leaked document from Germany, which has effective veto control over the Troika, laying out proposed conditions under which it’s willing to continue to fund Greece.

The mechanics of a Greek debt restructuring, as laid out by Gulati and Zettelmeyer, are absolutely fascinating to a sovereign-restructuring geek like me. But I’m not going to get into the details here. Suffice to say that in order for the restructuring to work, the Greek bonds currently held by the ECB need to be tendered into the exchange, somehow. There are various ways that this can happen: the ECB can tender its bonds directly; it can sell them to the EFSF, which would then tender them; or it could even sell them to Greece, which would tender them. But what it can’t do is sit back and continue to collect interest on those bonds while expecting all the private-sector bondholders to voluntarily take a massive haircut. Too many hedge funds own Greek debt now; if the old bonds continue to get paid out, then the hedge funds will simply refuse to tender, and the exchange offer will fail.

The point here is that the Greek bond exchange has to be worked out in very granular detail with the Troika, because the ECB is going to have to play a central role in making it work. If the markets think for one minute that the ECB’s bonds won’t be tendered into the exchange, the deal is almost certain to fail. On the other hand, as Gulati and Zettelmeyer explain, if the ECB’s bonds are certain to be tendered into the exchange, then Greece can structure a deal where it makes no sense to hold out at all, since holdouts would end up with illiquid and hair-cut Greek-law bonds, while anybody tendering would end up with English-law bonds which had much stronger bondholder protections and much greater liquidity.

So, what’s the Troika going to demand, in return for cooperating with the exchange and helping to ensure its success? More of a fiscal union, that’s for sure — which means real European control over how and where Greece spends its money. As the leaked document explains, “Greece has most likely missed key programme objectives again in 2011,” and “will have to significantly improve programme compliance in the future”, by “shifting budgetary sovereignty to the European level for a certain period of time”. That’s the reality of how bankruptcy works: if you run out of money, then anybody willing to lend you money can generally call whatever shots they want. And the fact is that monetary union, as we’ve seen, simply can’t work if there’s no fiscal union, with Europe having some kind of fiscal control over its member states.

The big problem with the leaked document is not the violation of Greek sovereignty, then. Rather, it’s the manner in which Greece’s new fiscal overlords are intending to treat the country’s debt burden. “Greece has to legally commit itself to giving absolute priority to future debt service”, it says, which is fair enough — California does something similar. Some bondholders like such things. But they don’t mean much to me: as I said in the Californian context, if you can break your promise when you default, you can break your promise to privilege bonded debt over other obligations, as well.

But the document goes significantly further than just giving Europe a say in Greece’s fiscal decision-making and asking for largely-meaningless promises from Greece. Check this out:

De facto elimination of the possibility of a default would make the threat of a non-disbursement of a GRC II tranche much more credible. If a future tranche is not disbursed, Greece can not threaten its lenders with a default, but will instead have to accept further cuts in primary expenditures as the only possible consequence of any non-disbursement.

In English, what this means is that Greece has to open itself up to a double fiscal whammy. Greece is going to be running deficits for the foreseeable future, and needs to get the money to cover those deficits from the Troika. Now, what happens in future, post-restructuring, if Greece gets into a fight with the Troika, and the Troika doesn’t give Greece the money it needs? As things stand, that would be a very bad outcome indeed. Greece could default on all its debt obligations, but it’s still running a primary deficit, so it would need to make even bigger fiscal cuts, or try to raise taxes even more, in order to bring its budget into balance. The result would be worse austerity, and an even deeper recession.

Under the German proposal, things get significantly worse than that, for Greece. Essentially, if the Troika cuts off funding, then Greece still needs to make all of its debt payments, on top of its primary deficit. The resulting austerity would be devastating — as Germany, of all countries, should know. After all, the burden of crushing German obligations after the Great War was largely responsible for the rise of… OK, enough. I’m not going Godwin here. But the point is that Germany is trying to take away Greece’s option to default. Interfering with Greece’s fiscal sovereignty is one thing, but this goes way too far.

I can see how Europe might want to give itself some kind of control over total expenditures and revenues in Greece. But the relative priority of expenditures — whether Greece wants to spend its tax revenues on debt repayment or on hospitals, for instance — must be left to the Greeks.

The reason all of this is going on, of course, is that the Troika’s interests and Greece’s are far from aligned. The Troika wants to stop having to fund Greece, and therefore wants Greece to regain access to private markets as soon as possible. Greece, on the other hand, is more interested in domestic growth at this point, so long as the Troika will continue to provide funding while private markets are closed. At the margin, then, the Troika wants more fiscal constraints (and hoped-for access to bond markets in future), while Greece just wants to get out of recession and start seeing some kind of light at the end of the tunnel.

Or, put it another way. Greece wants long-term debt sustainability, which means growth. The Troika, on the other hand, is less interested in the long term: it just wants the private sector to take over in terms of funding Greece as soon as possible. And the private sector, while it does care about long-term debt-sustainability calculations, also cares about many other things, like governing law and the constitutionality of default and the probability that Greece will continue making bond payments even if Troika funding dries up.

All of which means, weirdly, that bondholders would be better off lobbying the Troika than they are negotiating directly with Greece. After all, the Troika is really calling the shots here. And the Troika wants bondholders treated extremely well — after the restructuring. So if bondholders want things like English-law bonds and constitutional amendments, they should probably be asking the Troika for them, rather than Greece. Greece has no real reason to give them such things. But it can easily be forced to, if that’s what the Troika demands.


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Growth? Where exactly is it supposed to come from? No one has the slightest idea, that’s why we get enormously long articles about the minutiae that are at best relevant for the next 30-60 days. Two things only matter: 1) How will get Greece to a primary surplus quickly, which gives them a lot of independence? Probably only through a (further) massive downward adjustment of costs, primarily wages. Yes, that will mean some social unrest, but the vast majority of Greeks have already understood that it is unavoidable. 2) How can the restructuring be credibly done to make it both meaningful and minimize the likelihood of Portugal, and all other periphery countries, demanding the same treatment? Because let’s face it, there is simply no justification to treat the long-suffering Portuguese, Spaniards, Irish and Italians any different from the Greeks, and any pretense otherwise is not going to hold. Again, no answers, because there are no easy ones.

Posted by Abulili | Report as abusive

You are largely right, I believe, that this isn’t about sovereignty. Really, I don’t think most Greeks care about that since they don’t trust their own gov’t, for good reason. The poison for the Greeks was the catch: public expenditure takes a back seat while debt service rules the roost.

By the way, there are many articles out there now that show Greece actually has a primary surplus at this point.

Posted by DanAllen | Report as abusive

“the troika’s interests”? One member of the Troika (the EC) is primarily interested in getting re-elected and this member dominates the other two. So the proposal is written to pander to the voters in Germany, who, like all voters, have the attention span of a chipmunk. The ultimate solution is the same as always. Default, exile from the capital markets, forced balancing of the budget. The suffering will be immense, and serve as a warning to everyone. To the bondholders without CDS’s to be more careful about who they lend to. To the banks who wrote CDS’s to be careful about derivatives. To the citizens of incompetent governments to be more careful about who they vote into office.

Posted by revelo | Report as abusive

“the new big worry is that Greece will fail to come to some kind of agreement with the Troika — the official-sector entities which are going to fund its deficits for the foreseeable future.”

-Felix that deal dosen’t exist. The problem is that the Troika is not willing to fund Greek deficits for the forceeable future. Why on earth would they be?

I’ve read everything I can get my eyes on about the greek debt crisis because I think it is a tradegy which will play out repeadetly… I have yet to hear a strong case be made for a multi-year phased bailout for the greeks. What does Europe get in return? Sure they might be able to sell a few more BMW’s or Benz’s… but no one has ever gotten rich selling something on credit and writing off 75% of the debt have they?

Posted by y2kurtus | Report as abusive

This is the problem that comes from relying on credit to float consumers into the heady clouds of “I can buy anything I like” when in actual fact there was no money in the kitty. We’ve just lived through a decade or so of delusion and have now hit the brick wall we pretended wasn’t there.

Real growth will only come from breaking our lust for the cheapest at all costs (those costs including our own jobs). The West is addicted to excess, and no voter is going to vote against that.

Posted by FifthDecade | Report as abusive

How is it that everyone just assumes that a Greek expropriation of its bondholders requires the bondholders to go to Athens and they have no other recourse? Mikhail Khodorkovsky has recourse to the European Court in Strasbourg but Paul Singer doesn’t?!

Every scenario for a Greek default (illogical, I know, but still) assumes that Greece will continue to be a Eurozone member, i.e. to run payments through Target-2. Greek assets will be all over the map including in other European CB’s which (Bundesbank, I’m looking at you) don’t have sovereign immunity.

How is that all going to work, I still wonder.

Posted by johnhhaskell | Report as abusive

Everybody knows, that Greece has again failed to fulfil the commitments. GDP deficit is not even falling. Stop all payments, and let this sovereign nation chart its own course, without our money. Seize all assets, close the borders. period.

Posted by genauer | Report as abusive