Eurozone Overexposed

Greece is once again the focal point of efforts to stem the bleeding of investor confidence and save the eurozone. Intense negotiations continue on the precise terms of the restructuring of privately held debt in the struggling Mediterranean country. Agreement is a necessary condition for the approval of a second bailout package from Greece’s eurozone partners and the International Monetary Fund (IMF), which, at 130 billion euros or more, will exceed the first one.

On Friday, it looked as though the Greek government and the Institute of International Finance (IIF), the global banking lobby group, were close to a deal and a tentative agreement on interest rates, averaging out around 4 percent for coupons on the 30-year bonds issued in exchange for Greece’s existing debt. As the day progressed, however, it became clear that, even though the Greeks and the bankers had reached the essentials of an agreement, the deal could not be finalized. The IMF and the eurozone countries, in particular Germany, were adamant that the coupons issued to the private sector should have an interest rate of no higher than 3 percent, otherwise Greece’s debt would not be rendered viable. On the face of it, this is peculiar: Why did the IMF and the Europeans scuttle the deal when the Greeks were willing to accept it? Do they care more about the viability of Greece’s debt than the country’s own government? Well, no—but they do care deeply about their own exposure to Greece, which they have come to view as a black hole of debt, into which endless money flows, with no results to show for it. They know that the more losses they can force the private creditors to take, the less they will have to pony up themselves—and the less likely it is that a new restructuring of Greek debt will be necessary in the future, which could involve losses even for them.

The IMF in particular has taken a very dark view of the Greek situation lately. Its confidential yet curiously widely disseminated Greek debt-sustainability assessment (DSA) in late October, which served as the basis of the October 26 European Union summit agreement, posited that a 50 percent face-value haircut on privately held Greek debt would reduce Greece’s ratio of debt to gross domestic product (GDP) from around 160 percent, where it hovers today, to 120 percent by 2020. This assessment, already considerably more pessimistic than earlier prognostications, was itself abandoned as too rosy by the IMF. The troika of Greece’s official lenders now estimates that the recession will be 3.8 percent this year, as opposed to the 2.9 percent predicted in the budget parliament passed less than two months ago. They also forecast negative growth for 2013, which would be a devastating sixth consecutive year of recession for the country. According to Greek media reports, the IMF’s new DSA for Greece foresees debt levels of 150 percent of GDP in 2020 if the haircut stays within its current parameters. 

The IMF’s hard-line stance has greatly annoyed the bankers’ lobby. Sources with direct knowledge of IIF deliberations mentioned last week that private creditors’ representatives are particularly incensed that the IMF has stayed away from the negotiations, arguing disingenuously that the matter was between Greece and the banks, while at the same time holding an effective veto over the outcome—a veto which in fact it went on to wield on Friday.

The most crucial question looming over a potential deal is whether any agreement will garner enough support among the banks and hedge funds to eliminate the need for a law that will impose the same losses on all holdouts as those suffered by the “voluntary” participants. This is a move that Greece has threatened to make. If it goes through with it, though, ratings agencies will classify Greece as in default, Payments on credit-default swaps will be triggered with unpredictable consequences, and lawsuits will start raining down on the Greek state.

The most potentially cataclysmic development, though, involves the European Central Bank (ECB): A forced haircut will mean it, too, will bear heavy losses on the Greek bonds it has bought on the secondary market, about 45 billion euros’ worth, purchased at around 75 percent of face value. Given the feeling in Frankfurt that the ECB has already bent its rules near breaking point to salvage a situation made critical by eurozone governments’ failure to take the necessary steps, it is arguable that Mario Draghi and the ECB’s governing council will be in no mood to further facilitate crisis management. With Greece officially in default, the ECB may decide to stop accepting Greek government bonds as collateral in order to lend to Greek banks. This will leave them without money and will effectively force Greece out of the euro. 

The target set for the offer of the bond exchange to Greece’s private creditors is February 13. On March 20, a 14.4 billion euro Greek-bond payment comes due. In the two months until then, the country’s future in the eurozone will be decided and with it, in no small part, the future of the eurozone itself.

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