The Prodigal Greek

The Greek crisis through a different prism

Coulda woulda shoulda

with 2 comments

“We knew at the fund from the very beginning that this program was impossible to be implemented because we didn’t have any — any — successful example. The argument that is used usually by the troika in order to criticize Greece — and to ignore their mistakes — is that the deep recession is because of the non implementation of the structural reforms”.

It is this statement in the New York Times last Tuesday from Panagiotis Roumeliotis, who until last January was Greece’s representative at the IMF, that rekindled the public debate in Greece about those momentous days of spring 2010. Considering the ferocity of the impact that the two ‘bailout’ programs had on the Greek economy and people’s livelihoods, for many in Greece the period between March and May of 2010 is very sensitive and critical. The events that led to the signing of the first Memorandum of Understanding are seen as shaping the country’s future for many years to come. There is a question that remains unanswered in everyone’s mind, could Greece have gotten a better deal?

As much as Greece’s political establishment was completely unprepared to deal with the biggest economic crisis in the country’s modern history, Europe and its institutions equally did not demonstrate any signs of urgency. Sticking with the nonchalant style that allowed Greece to reach an almost bankrupt state, Europeans underestimated the fundamental problems of Greek finances and believed that the issue would resolve itself if Athens simply followed a stricter budget policy that would appease markets. Greece’s obvious solvency problem was seen as a confidence issue, a diagnosis that could not have been further from the truth – as confirmed by the current extent of the crisis. Characteristic of the lack of importance that Germany attached to the Greek issue is the obvious prioritisation of the North Rhine-Westphalia state elections in May 2010. This was the most pressing matter on Chancellor Angela Merkel’s political agenda, rather than finding a way to address the Greek – and imminent euro – crisis.

When the crisis hit home and Greece’s yields were climbing towards 7% in March 2010, Europe was completely unprepared to deal with the situation, let alone a debt restructuring. As such, the program agreed was designed to buy time, put the necessary mechanisms in place to deal with the issue at hand while at the same time attempting to contain the problem and reduce any exposure. According to data from the Bank of International Settlements, euro area banks at the end of the second quarter of 2010 had a combined exposure to the Greek state of approximately 50 billion euros. Just between German and French banks the exposure was approximately 34 billion euros, 19 billion and 15 billion euros respectively (table below).

Bank of International Settlements, Quarterly Review, December 2010

At the end of the first quarter of 2010, Greece’s government debt stood at 309.7 billion euros (134% of 2009 GDP) held by the private sector and majority of it in bonds denominated in euros and governed by Greek law. A decisive Greek debt restructuring, in similar terms to the PSI that concluded early this year, would have relieved Greece of a significant portion of its debt burden. But the relief for Greece would have provided European countries with a new problem, given the exposure of their banks to the Greek state at the time.

As such, instead of dealing with the issue of Greek solvency and the health of the balance sheets of their domestic banking systems following a Greek debt restructuring, they dealt with the Greek problem as one of liquidity. They sought to provide for 2.5 years financing that would fund the Greek budget deficit and ensure the uninterrupted servicing of the debt burden, thereby safeguarding euro area banks, on the assumption that Greece would be able to return to the markets in the first quarter of 2012 (Table below) – an assumption that in itself illustrates the misdiagnosis of the problem.

The Economic Adjustment Programme for Greece, May 2010

By the time the decision to restructure Greek debt was made in October 2011, the country’s burden had significantly increased as a result of the troika’s financing line. It stood at 355.6 billion euros in the end of 2011 or 165% of GDP and a large portion of it was held by the ECB as a product of the purchases under the Securities Market Programme. Subsequently, only an amount of just over 200 billion euros, compared to 309.7 billion euros before the ‘bailouts’, that was privately held was in scope of the PSI, as troika loans and ECB holdings were excluded from the exchange, significantly reducing the amount of debt that was lifted off Greece’s shoulders.

An immediate debt restructuring in 2010 would have facilitated Greece’s fiscal efforts as it would have significantly reduced the servicing costs and would have pushed back maturities, reducing the financing needs in the medium term. More favourable terms in the official sector loans, that were initially set at 400 basis points over the three-month Euribor, would not have added to Greece’s interest costs, which shot up to 15 billion euros in 2011 from 11.9 billion in 2009. A longer period of fiscal adjustment would have had a less severe impact on the economy.

There is little doubt that Greece did not get the best possible deal in 2010 and did not take advantage of probably its strongest negotiating position during the crisis. The program was not designed to assist a partner at a time of need. It intended to buy time, limit the damage and at the same time send a clear message by making the costs and terms so punitive that no one else would even think of asking for official sector support. That Ireland and Portugal followed the same path within a year of Greece’s first bailout is also an indication of the misreading of the problem by Europe’s political elite.

However, in the domestic public debate surrounding the days of spring 2010, there should be no illusions that there was a magical solution to resolve an issue that was the product of years of dismal management of the public finances and the public administration.

Even if a debt restructuring had taken place back in the spring of 2010, Greece was running a primary deficit in the region of 24 billion euros in 2009. The government’s excessive deficit would still need to be addressed and somehow financed. Greece would also need additional funds to recapitalise its own banks, following the recent PSI recapitalisation needs are close to 50 billion euros. With Greece most probably locked out of the markets after a debt exchange, the financing gap would have to come from the official sector for an amount similar to the one of the first program.

The spring of 2010 was the time of reckoning for Greece’s political establishment.



Written by Yiannis Mouzakis

July 30, 2012 at 7:19 pm

Posted in Economico, Politico

Tagged with , , ,

2 Responses

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  1. I totally agree with this analysis but would like to add the following.

    EU-authorities were totally overcharged when the Greek crisis erupted. No surprise, they never had to deal with a balance of payments crisis of a member country before. But they cannot be forgiven for not asking those for advice who would have known. Instead, they arrogantly refused such advice (“We can handle the situation on our own!”). Very prominent Americans who had been masterminding Latin American and other sovereign debt restructurings (Bill Rhodes & Co.) offered their advice and were told that the experiences in emerging markets could not be applied to an EU-member.

    Greece was, understandably, even more overcharged. How could one expect a country like Greece to be up to date on solutions for balance of payments crises? But there, too, advice was ignored. And as recent relevations suggest: advice was brutally ignored.

    So here you have it. Call it the blind leading the blind or, as the Spaniards say, “tontos con iniciativa”.

    So much had been talked about the subject of rescheduling and, possibly, a default. Like that would be the end of the civilized world. Anyone with experience outside Europe could have told EU-authorities what the Chief Economist of Citibank once said: “The Europeans did not know that sovereign debt reschedulings have come a dime a dozen in recent decades”. Put differently, a debt rescheduling with existing creditors (NOT a debt restructuring from private to public creditors) is the most natural thing in the world when a country hits balance of payments problems!

    Where I do not share the author’s views (and those views have been expressed by most others, certainly by Greeks) is this worry about being cut off from external financing if there is a rescheduling.

    The nature of an orderly rescheduling is such that it has to be consensual. Even if there were to be a default, it would be a “consensual default”. When things are consensual, it is in nobody’s interest to allow any event which would cause the pyramid to collapse. The major reason why no one would have to fear this is that, behind the scenes, officialdom (normally IMF only; here also the EU) makes sure that no accidents happen along the way. They basically steer the rescheduling with existing private creditors into the direction that they want to have. No institutional creditor of any repute will ever refuse a reasonable sovereign debt rescheduling proposal because he can’t afford to do so. There will always be a couple of odd balls like, for example, a small family office which has nothing to lose and much to gain. Well, those simply get paid out. Just like one should have paid out small private investors. The money involved is minimal and the potential problems one gets rid of by doing so are enormous.

    One principle of any debt rescheduling is “pari-passu”. Everyone must have, at the end of the exercise, the same risk position as before and there cannot be any preferential treatment (except as mentioned above). In other words, the risk exposure after the rescheduling would have had to be the same as outlined in the article’s table before the rescheduling. No one can pull a fast one or grab for the cookie jar. All must remain in the same boat. If someone were to offer only one creditor, like Finland, extra collateral, the whole structure would come down like a house of cards.

    The debt rescheduling takes care only of the existing debt. It does not address the issue of Fresh Money. Every creditor who agrees to the debt rescheduling will require that the Fresh Money comes from official sources (IMF, EU) and that those official sources will negotiate, on a government-to-government basis, the necessary conditions. So, even with a successful debt restructuring with existing private creditors, the borrowing country could not avoid sitting down with a troika to negotiate those conditions.

    Again, my point is that no worry would have had to be had about coverage of the Fresh Money requirements, provided everything would have taken place consensually. That is how sovereign debt reschedulings have been handled for decades and someone will need to assume responsibility for not having handled them that way with Greece.

    Klaus Kastner

    July 30, 2012 at 8:38 pm

  2. […] that in early 2010, German and French banks held an estimated 34 billion euros of Greek bonds. They reduced this exposure in the ensuing months but were aided by the fact that until this month, about three quarters of the […]

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