Sunday 4 December 2016

Greeks have merely delayed day of reckoning

Published 03/07/2011 | 05:00

IN the end, the eurozone limped through yet another week of crisis more or less intact. While the threat of immediate and terrible financial destruction was sufficient to ensure that the Greek parliament voted in favour of yet another austerity programme, the failure to tackle the underlying issues means that the day of reckoning has been postponed rather than averted.

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Last week's vote means that Greece will receive the latest €12bn tranche agreed under its May 2010 EU/IMF bailout package and that the country won't go bust immediately. Unfortunately, the fact that an immediate Greek default has been averted shouldn't blind us to the reality that the country, which owes its creditors €340bn, is hopelessly insolvent.

With the immediate crisis having been at least temporarily resolved, the EU and the IMF must now cobble together a new Greek rescue package. This is expected to be at least as large as the €110bn May 2010 package and will be the second bailout the country has required in the space of just over a year.

The fact that the May 2010 bailout quite clearly hasn't worked should make us all sceptical. Why should the medicine prescribed without any apparent success 14 months ago work now?

After all, it was none other than Albert Einstein who once defined insanity as doing the same thing over and over again and expecting different results. This seems to be a fairly good definition of what the EU and the ECB are trying to do in the case of Greece.

The only new ingredient added to the mix last week was the proposal unveiled by French President Nicolas Sarkozy that his country's banks, which have a total exposure of €65bn to Greece, should extend the repayment period on some of their Greek loans to 30 years.

While the French plan would have represented a significant step forward had it been put forward at the time of the May 2010 bailout, it is now far too little, far too late.

In any event, on closer examination, there is far less to the French plan than apparently meets the eye. Under the plan, Greece would repay €60bn of maturing bonds and get 70 per cent of this amount, €42bn, back. However, it would only actually receive €30bn in cash with the remaining €12bn being invested in 30-year Triple A-rated bonds with an annual interest rate of 5.5 per cent. The rolled-up interest on these Triple A bonds would ensure that the banks were repaid their principal after 30 years.

In addition, the Greeks would also pay a 5.5 per cent interest rate on the other €30bn, plus up to a further 2.5 per cent depending on the country's economic growth. It has been calculated that Greece could end up paying as much as €101bn interest on the money over 30 years if it agreed to the plan. Beware of French bearing (Greek) gifts.

Looked at closely it can be seen that the French plan is in reality not a breakthrough but more of the same, an overly complex mechanism that fails to deal with the pressing requirement to write down Greece's debts by at least 50 per cent.

This is what the market in Greek government bonds, with two-year bonds now yielding over 30 per cent, is saying. Credit default swaps (CDSs), the instruments bond investors use to protect themselves against the risk of default, are telling a similar story, with Greek government debt virtually uninsurable.

It is CDSs that may well prove to be the dog that has yet to bark in the unfolding debt crisis wracking the eurozone periphery. Cast your mind back to the events of September 2008. While it was the collapse of Wall Street investment bank Lehman Brothers that attracted most attention at the time, by far the biggest cost to Uncle Sam of the autumn 2008 panic was making good the CDSs on bonds backed by sub-prime mortgages that had been written by insurance company AIG.

While the US Treasury eventually turned a modest profit on the $750bn (€517bn) it injected into the American banking system, it had to kiss goodbye to most of the $180bn it was forced to pump into AIG.

Could something similar be about to happen with CDSs on the bonds of the eurozone periphery and not just those of Greece?

Are there banks, perhaps US and British, out there with large as yet undisclosed holdings of such CDSs that they would be unable to honour if the issuer of the underlying bonds, ie Greece, Portugal, Ireland or Spain, defaulted?

This would certainly explain the decision of US Treasury Secretary Tim Geithner to veto a proposal that would have allowed Ireland to "burn" some bank bondholders at the time of last November's EU/IMF bailout.

Any "burning" of bank bondholders would, of course, have triggered the payout of CDSs on those bonds. Is the ECB's apparently irrational opposition to any eurozone defaults based on its knowledge of hidden CDS exposures on the part of some major European banks?

If this does turn out to be the case, then the inevitable Greek default, probably followed by those of several other peripheral eurozone countries, may turn out to be even more damaging and disruptive than most of us had feared.

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