More Thoughts on Greece

Currency in Crisis

The European finance ministers approved an aid package for Portugal. Ireland is still seeking better terms. Although France's effective corporate tax rate is lower than Ireland's, Sarkozy is reportedly refusing to sanction some easier terms (lower rates extension of maturities on the aid package) unless Ireland makes a compromise on its taxes.

Greece's situation is far from clear. It is now appreciated that Greece will not be able to return to the capital markets as envisioned in last year's aid package. While something needs to be done, a consensus has not emerged, except that more effort on the part of Greece is necessary.

Last week the EC said this year's Greek deficit will be near 9.5% of GDP, rather than the 7.4% target. Last year's budget deficit was also larger than had been agreed upon. The IMF, EU and the ECB are currently in Greece evaluating the conditions and progress. A report is expected around mid-June, though there has been some indication that the report might not be ready for a week or so later.

Greece will have to prepare new proposals of reaching its deficit targets. To this end there is much talk about privatization. Greek officials are reportedly working on a 50 bln euro program, though the IMF indicated that this was "just" 20% of the property the government owns. No doubt Greece's creditors would like a more ambitious privatization program.

Greece is working on additional spending cuts. A package of something around 80 bln euros of spending cuts and assets sales is likely to be unveiled next month. The Greek government may also keep something in its pocket, so that when its creditors ask for more, which they are bound to (ie, not accept Greece first offer). it can unveil additional measures.

Talk of a soft restructuring, which appears to me a voluntary extension of maturities (average maturity of government bonds is reportedly just below 5 years). Juncker threw down the gauntlet. Europe would consider sanctioning this in exchange for deeper spending cuts and increased privatization efforts.

Clearly Juncker does not represent a consensus. France's Fin Min Lagarde and Belgium's Reynders rejected such talk, saying that it was not discussed at the recent euro zone fin min meeting. That said, the EU and IMF have or are in the process of formally extending the maturities of their aid.

There are other Greek creditors, outside of private banks, that may see less cost in extending maturities than forcing more difficult choices. For example the ECB is thought to have 40-50 bln euros of Greek bonds which it bought at a discount. It plans on holding the bonds to maturity. Greece's social security and other public entities have around 30 bln euros of Greek sovereign bonds (and is already assuming a 30% haircut).

The argument is that if these entities voluntarily extend maturities, that alone would provide some relief and it may enhance the chances of getting the private sector to do the same. Greek banks, for example hold almost 50 bln euros of Greek government bonds. They may prefer extending maturities, with the same coupon, especially for the bonds that are intended to be held until maturity.

In our review of past sovereign debt crisis, lowering service costs through lower interest rates and/or extending maturities is the first line of defense and rarely proves sufficient. As we have argued, a reduction of Greece debt burden would require a serious reduction in principle. The ECB, EU and Germany in particular, oppose such a course. Partly this is a function of moral hazard, but it is not just philosophical.

A restructuring of Greek debt of a magnitude necessary to reduce its burden to sustainable levels, would wipe out the ECB's capital, directly through the Greek sovereign bonds it owns and through the collateral it has accepted from Greek banks, which includes Greek government bonds and bank bonds guaranteed by the government, and zero coupon bonds issued by the Greek government and lent to Greek banks in 2008.

There is also the concern that if Greece restructures, why shouldn't Ireland and Portugal.

The real underlying problem few are even talking about. Even if Greece were to restructure and reduce its debt burden by a partial default, then what? Of the numerous measures already enacted and those still on the drawing board, how much has been devoted to boost Greece's competitiveness? Greece needs aid so it can pay its creditors today, but it needs a strategic plan and investment to boost its ability to compete in the world. Less than 1/100 of the brain power and ink spend on the Greek debt crisis is being used to boost Greece's economic prowess. Therein lies a tragedy in the making.