May 5th 2010,
Investors have decided that the Greek bail-out package is about as credible as Bernie Madoff’s business model, and that while the $US147 billion being pumped into the country might keep the game going for a bit longer, in the longer-run the numbers just don’t add up.
The hopelessness of the situation is made even more apparent after the violent protests that erupted in Athens overnight, which resulted in three people being killed during demonstrations.
There’s now a growing consensus that a major restructuring of Greek debt – where lenders are forced to take a haircut and write off some of their loans to the country – is pretty much inevitable.
Citigroup’s chief economist, Willem Buiter, takes this argument one step further. He argues that Sunday’s decision was not so much about “rescuing” Greece, as about escorting the country to a safe house so it can undergo the massive debt restructuring exercise.
In a note out overnight, Buiter, who was a member of the Bank of England’s Monetary Policy Committee before joining Citi, said that the eurozone has already made the decision to restructure Greece’s debt.
He says the decision to restructure Greek debt, and to force lenders to take losses on their loans “became unavoidable when the euro area decided not to lend to Greece at something close to the risk-free rate, but at 300 or 400 basis points over the swap rate.”
But if a decision on a Greek debt restructuring has already been made, what’s the point of giving the country a $US147 billion bailout package?
Buiter argues that there’s a huge political advantage to delaying the Greek debt restructure, because it makes it less likely that the French and German governments will have to pump capital into their banks.
Greece only gets the bailout package if it implements brutal spending cuts and tax increases. If Greece meets these conditions, the country will be running a primary budget surplus in 2013, even though the Greek government’s debt will have climbed to a whopping 150 per cent of GDP.
The official eurozone plan at that point is that Greece will be able to wean itself off eurozone and IMF funding. Instead, the country will go to the market and borrow money at an interest rate of 5 per cent.
But Buiter points out the problems in this thinking. Even if Greece is able to borrow at an interest rate of 5 per cent in 2013, the country would still be faced with a crippling interest rate bill. Greece would be doomed to perpetual stagnation as each year 7 per cent of total GDP would go towards paying interest on its debt. It is, he says, “disingenuous” to say that Greece’s debt levels will have stabilised at that point.
But, of course, that’s not really the plan. Instead the idea is to get Greece into a position where the country’s tax revenues cover government spending, and the country doesn’t need to borrow money to cover the day-to-day spending of its government.
Greece will then be in a position where it has a huge debt, but no primary deficit – which Buiter points out is “the exact circumstances that makes a default individually rational for the debtor”.
When Greece’s bailout package runs out at the end of 2012, there’s no way the country will be able to borrow at reasonable interest rates, because markets will be worrying that Greece will take the default option. So that would mean that the EU-IMF bailout package would have to be rolled over.
That leads Buiter to suspect that a restructuring Greece’s debt is likely to be made next year.
Of course, there is a strong logic to restructuring the debt immediately, because the sooner it’s done, the smaller the losses will be.
Buiter estimates that if the debt were restructured today, lenders would probably have had 30 per cent of the value of their debt wiped out. The problem is that this would have left the French and German commercial banks staring at huge write-offs. And there would have been huge embarrassment in Paris and Berlin if French and German governments were forced to step in and recapitalise their banks.
So Buiter says the plan must be to give the banks time to build up their capital reserves, or to shift some of their Greek exposure from their balance sheets onto the government’s balance sheet.
If Buiter is right, the banks will probably come through the Greek debt crisis in fine shape. It’ll be the German and French taxpayers who pick up the brunt of the losses.
by Karen Maley
@ Business Spectator
I have decided to post a weekly blog article on how my trades went last week (12 till 16 July 2o10).
Can the International Monetary Fund afford it if the rest of Europe’s ring of fire (Portugal, Spain and Italy, in descending order of crisis) starts to crumble? My back-of-an-envelope calculations don’t look good.
