Greece: will the Euro zone bank bail out be followed by default?

I have just been watching the Press Conference at the end of the European Central Bank’s meeting today and deliberately delayed my update on Europe to after it. Why? Because this was a particularly significant meeting surrounded by rumour and counter rumour and there was the possibility of  it making announcements which would affect economic life in Europe maybe for generations. Fortunately it decided not to do anything particularly ground-breaking today and decided on what Sir Humphrey Appleby of Yes Minister called “masterly inaction”.

A Revealing Statement

In one of his answers Mr. Trichet did give something away quite revealing. You see he said “fully independent” and “liasing” as being the ECB’s role in the response to the Greek crisis. In my view you simply cannot be both you are one or the other. This sort of muddled thinking seems common to central bankers at this time as Sir John Gieve formerly Deputy-Governor of the Bank of England said some similar things recently( I wrote about this in more detail in my update on April 30th). So when they announce that they are independent my advice is to remember that what they mean by it may not be the dictionary definition.

What happened today to unsettle things?

There were several rumours doing the rounds for example that Italy was about to be downgraded and that US banks were refusing to lend in Euros. These sort of things thrive in such uncertain times and in a fearful environment some start to actually believe them. What was more realistic in my view was nervousness about the state of the interbank market and what might be happening there. Many eyes would have gone this morning to the LIBOR fixes (including mine) but in truth we were none the wiser afterwards.

Part of the nervousness had come from the way that bond yields had risen for the countries involved in the European sovereign debt crisis. I shall give closing levels for ten-year government bonds followed by the spread with Germany’s ten-year bunds. Greece 10.58% (+7.71%), Portugal 6.16% (+3.29%), Ireland 5.57% (+2.7%) and Spain 4.24% (+1.38%).

These numbers are particularly concerning for Portugal as she is being hit quite hard by these changes. We are back in a situation where offering the bail out money is likely to cost her as her three-year bonds are again yielding more than the cost of the bail out. I have wondered about this problem before and the European Commission is now saying that there is a special clause in its agreement  for this and any losses will be subsidised by those who make a profit (according to the Wall Street Journal). So lets hope for their sake yields do not rise further elsewhere….

Also quite what the German Constitutional Court will say about subsidies to Portugal to help provide subsidies to Greece makes the mind begin to boggle I think!

Further Comment on the bail out

Having over this week analysed the so-called bail out for Greece I have come to the conclusion that it is in effect a bank bail out. I came to this conclusion earlier this week but I did not take the next step which I will introduce now. If I think this and if I assume that the designers of this plan are logical then there was a missing link in it which of course was some form of debt restructuring. One can only conclude that they felt that Europe’s banking system was not up to the shock.

However in the end I feel that  it will be necessary and the delay caused by the plan to let Europe’s banks with particular reference to Greek, French and German banks off the hook will cause further pain to Greece. You see there are now two rather dark possibilities. One is that Greece’s population will realise that the bail out combined with austerity is not a long-term solution to their problems. The other is that Europe’s authorities are allowing their banks to recapitalise before they take the hit of a restructuring. This would certainly explain why Greek short-term bond yields are rising when there is an obvious carry trade available. Perhaps the main players already suspect the game and wish to avoid further losses.

My old tutor from my undergraduate days at the LSE (Willem Buiter) has taken this logic a step further and now concludes that there is already a plan for restructuring of Greek debt but not until 2011 when the debt has been transferred from the banks to other places including the taxpayer. I do not necessarily completely agree with this view but it is hard to discount entirely. If true it is a deeply cynical position from Europe’s politicians.

There is also a horrible possible irony here as what if a plan to bail out the banks is really helping lead to a freezing of interbank markets and therefore bank trouble and maybe failures?

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10 thoughts on “Greece: will the Euro zone bank bail out be followed by default?

  1. Trichet needs to step up to the plate and take ownership of the Greek bonds the ECB hold as collateral. The repayments can then be restructured over a much longer timeframe. That at least will take Greece out of the pressure cooker and it wouldn’t necessarily be called a default. Also give the IMF carte blanche over the Greek economy restructuring that needs to be done. I think the UK might have to do something similar!

  2. Shaun,
    I watched a few days ago a greek professor of economics (Yanis Varoufakis – PhD Economics, University of Essex), he is rumored to be close to Papandreou. He said that the whole rescue plan, is an attempt by Europe (Germany and France) to buy time. Time for their banks to get rid of greek bonds. They are going to give the ammount needed to reach 2011 and then default will follow.
    If something like this is true, the first question that comes in mind is who is going to buy this debt. If greece defaults in 2011, will the Euro be saved? Or this will be the end of it?

    • Hi A Greek
      Your first question is one I have been pondering after writing my section on Greece today. I have come to the conclusion that those in power in the euro zone seem to have felt they could keep their intentions (i.e their banks to slip gradually out of Greek government bonds) quiet and that everyone would concentrate on their rescue plan. The best suggestion I can think of is that they hoped that say “junk” hedge funds would buy Greece’s debt. Or that they could also park some of them at the ECB. Either way I think that plan has been exposed!

      As to the Euro being saved I am not so sure. I certainly think that Europe’s politicians will try and press ahead with their “federal project” but I am not so sure that they will get support from their voters for it. Markets may have an impact particularly if they repeat the gyrations of tonight ( I was happily following the world 20/20 cricket when I discovered the US Dow Jones stock market index had fallen nearly 9% at one point). I fear that such gyrations may continue in one form or another and if they do the original flaws of the Euro will keep coming back to haunt it.

  3. Regarding who will receive the debt, it’s quite possible that Greek’s assets will be looted or underwritten as guarantees.

    Greece’s debt will be converted from 0-guarantee-bonds to bi-lateral loans between sovereign nations, which is quite harder to erase, since it has the form of a contract – and maybe even guarantees.

    For the time being, Greece performed an audit with the intention of “using” the state property (lands, buildings, etc). Ministry of finance claims it to be approximately 200 bn euro. Even islands may be sold off to repay the debt. Of course this is treason, for the average Greek. Who in their right mind (having the nation’s interest at heart), would not take the option of defaulting on 320 bn 0-guarantee bonds, instead of converting this debt to guaranteed bilateral loans or selling his a$$ off to repay the lenders?

    Anyway, the whole thing is set up from the inside. The opposition leader in Greece is quite open in claiming that they gave Papandreou a deficit crisis, which Papandreou CONVERTED to a borrowing crisis (they’re short of saying he did it on purpose – leaving imagination to fill the gap with incompetence). Even tonight, one parliament member (Oikonomou) from Papandreou’s party PASOK, said he was not convinced that the IMF and austerity measures were the only way to go and for that reason he did not vote in favor of the measures (PASOK ousted him from the party thereafter).

    A wider view on the whole assets + borrowing crisis issue can be found in these three links:

    http://grcrisis.blogspot.com/2010/05/greek-debts-as-contrast-to-greek-assets.html
    http://grcrisis.blogspot.com/2010/05/greek-lending-crisis-inside-job.html
    http://grcrisis.blogspot.com/2010/05/greek-lending-crisis-who-benefits.html

  4. Thanks for the answer Shaun,
    Sadly Europe’s politicians are too small for such a big project. The cultural and other differences between the north and the south are too great.
    As for Greece there are many here who believe that we needed that in order to wake up. For the last 30 years the country was heading to the wrong direction.

  5. Hi Shaun,

    do you really think it will be a haircut for Greece debt in 2011 or a complete default? The knock on implications of both are still huge, given the interst hikes for other nations. Would it be possible that all central banks no longer recognise the rating agencies for policy desicions? The practise only started in the 70s so they managed without before, so should be able to manage without afterwards. ECB ignoring rating agencies for Greec debt could be a first step along the way.

    I have been reading some analysis in the Dutch media that the Northern part of the Euro area is able to buy up all the debt of the Southern part and still keep the Euro-area wide debts at a managable level. The cost for the Dutch state are estimated at 95 Billion euros to achieve this. Which is huge, but still a managable amount for the Dutch state. Only question here is political will power in the Euro area, and a public willing to stumag this. The overall financial situation of the Euro area as a whole is still concidered “healthy” from that perspective, but unlike California and NY in the USA there is no firewall mechanism to protect individual states on the brink of default.

    Personally, I would prefer the 300 Billion euro option and buy all Greece debt and restructure for a decade at a low interest. This is now, after the Greec parlement vote, the most likely “winning” case for all. And if possible firewall Portugal and Spain as well from market speculation a.s.a.p. Do you know if it is possible to have a mandatory sale of holders of Greec debt to such an aid package deal, just as shareholders can be overruled by a state?

    On another note, instead of nuclear, would it be possible to build a Greec bad bank that will buy up the state bonds funded by the other Euro members? To disconect the Greec debt from the financial system and make it clear were the risks are.

    As to private profits and communist losses, personal liability for the management sure sounds sweet now. There needs to be some retrospective legal changes that allows for punishments of unethical behavior. The welfare of a continent has been put at risk for personal gain of a few. Plus we got plenty of space in Dutch jailes for politicians and banksters, recently one jail was closed due to lack of criminals. We now know were they went. 😉

    • I think that the difference between a haircut and default is now in Greek hands. I believe that a haircut is necessary and should be put in as an overall package but as we know the current euro zone package does not include it.

      Northern Europe probably has the money to buy up Southern Europe’s debt but my question to those who propose it would be, what do you intend to achieve by this? Saying you can and saying you should are very different. For example if all of Greece’s debt is purchased are you not feeding another moral hazard? i.e they borrow again and you sit their thinking did we encourage that?

      I am glad you have some space in your prisons, the UK’s are rather full!

  6. ‘As to private profits and communist losses, personal liability for the management sure sounds sweet now. There needs to be some retrospective legal changes that allows for punishments of unethical behavior. ‘

    Don’t expect that if the UK is anything to go by…………

  7. Weird question but how come that the Euro is the only currency union that needs a federal government? The CFA, XCD seem to be doing fine without one for decades.

    • Hi Jacob and welcome
      It’s a good question to which there are several strands of an answer I think. I do not pretend to be an expert on African Francs or the East Carribbean Dollar but what has hit the Euro hard is that the lack of political and fiscal unity and control opened a flank or weakness. Now whilst it was always there, it is true that there were periods up until now when it too was considered a success by some. However the one thing which has exposed it in my view was the lack of economic convergence which the founding fathers of the Euro were plainly hoping for. Indeed we have had divergence and quite a considerable one. Now they may have been able to struggle on for a while like that but then the credit crunch hit and the gyrations it produced has exposed problems in the Euro and euro zone.

      So again I am not an expert say in the Carribbean economic situation but I would suspect that they have not been challenged in this way and that their underlying economies are more similar than Europe’s

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