Europe needs a debt jubilee
James Saft is a Reuters columnist. The opinions expressed are his own.
Greece cannot be saved without debt relief, and debt relief for Greece may mean what amounts to a mass Jubilee with debt write-offs and recapitalizations needed for weak banks and nations across the euro zone.
Little wonder that officials delay, deny and only belatedly try to negotiate openly with reality.
Greece’s credit rating was downgraded by Standard & Poor’s to B on Monday, taking it two steps further into junk territory, just days after a secret meeting of euro zone finance ministers gave rise to rumors that the country would soon leave the common currency zone.
EU officials have said a new aid package for Greece (and Ireland) is on the way, and S&P foresees commercial creditors paying their share too, which even if it is only an extension of the maturity of the bonds is tantamount to a default.
“Although an extension of maturities with no principal discount would likely imply a recovery greater than 50 percent, our projections suggest that principal reductions of 50 percent or more could eventually be required to restore Greece’s debt burden to a sustainable level, given trend growth potential of the Greek economy,” S&P said in explaining its action.
This brought on a fit of scoffing from Greek officials, who said there had been no deterioration since S&P’s last evaluation in March. Gentle notice to officials: ratings agencies are famous not for being always wrong, but for being behind the curve. When they are downgrading you furiously it means everyone else already knows you are a poor credit.
For evidence of this you need only look at financial markets, which have been busily downgrading S&P in hard currency terms. Greek two-year debt is currently yielding north of 25 percent, while Greek debt overall is trading at levels that imply a 40 percent discount.
The overall message from the hard-hearted financial markets is that austerity without meaningful debt relief will not work. As odious as it may be to German and Finnish taxpayers, Greece is not going to be able to bear the load if its economy carries on shrinking. The same is self-evidently true for Ireland and Portugal. Spain’s saving grace, if you can call it that, is that it is so big and important that by the time we get to imposing conditions on it we will have moved to a far more radical game plan, one involving significant debt relief.
A GRAND RECAPITALIZATION
The European quest to maintain the fiction that the debts will be repaid fully is particularly quixotic, in that the ECB is strenuously acting to keep a lid on inflation, most recently by lifting interest rates by a quarter of a percentage point. While U.S. policy is not above its own polite fictions, at least it is consistent; they are still playing the same game of inflating spending by inflating asset prices, hoping that eventually inflation will eat gently away at the debts.
The ECB will hardly emerge unscathed from a restructuring of Greek debt, at least from one bold enough to lift the country out of its problems. The ECB is profoundly exposed to Greece, not just directly through bonds it has purchased, but also as a massive (91 billion euro) lender to Greek banks. And what are those loans collateralized with? Much of it are loans issued by or guaranteed by the Greek state.
JP Morgan estimates that a 50 percent reduction in Greek debt obligations would cost the ECB 32 billion euros, or about 40 percent of its member central bank’s reserves and capital. Such a haircut might be withstand-able, though it would likely wipe out the capital of the Greek central bank, but such a haircut, when it happens, will not happen in isolation.
“We need a very comprehensive solution very fast, not only for Greece but for the other problem countries,” Peter Bofinger, one of the German government’s wise men economic advisors told Reuters Insider television.
“If we don’t reach this solution I am not sure that the euro area will remain intact for the next 12 months.”
Greek banks will need to be recapitalized, for a start, not a terrifying prospect, but so too quite likely will many banks outside Greece, and not solely due to losses on Greek credits.
While authorities may want to put off a Greek restructuring until 2013, when new measures to handle bailouts come into force, they’d be far better off addressing the multiple bailouts that are needed, including of banks, all at the same time.
That’s because a Greek restructuring will speed contagion to Spain, to Portugal, to Ireland and to banks. If that restructuring is inevitable, and it looks as if it both is and is coming soon, then better to have an orderly debt Jubilee, with taxpayers and shareholders sharing the pain, than to allow the markets and that old enemy, events, to set the agenda.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)