Why the musings of a Greek debt buy-back deserve to be treated with contempt

A recent report by German daily Die Zeit filled the newspaper columns and our television screens with rumours of a brilliant solution for the Greek debt. And when Reuters and Bloomberg beamed it around the world, false promises of a final resolution for the euro crisis began to spread like a bushfire. In this post I want to dash these truly great, albeit wholly misplaced, expectations. My point will be that the proposed scheme will not be adopted and that, even if it were adopted, it would not make an iota of a smidgeon of a hint of a difference to the unfolding euro crisis.

But first, let us take another look at the Reuters cable which started this particular ball rolling. It said that “officials in Germany’s finance ministry are preparing an emergency plan to handle the fallout if Greece defaults or needs to restructure its debt… One source close to the finance ministry said German civil servants were analysing what a Greek restructuring would mean for German banks as well as the stability of the euro zone. “They have started to consider the unthinkable,” said the source…”

That debt restructuring is discussed is natural and welcome. But then Bloomberg muddied the picture by adding: “Greece would be allowed [by Germany] to buy back government bonds with funds from the European Financial Stability Facility made available to Greece ‘with favorable interest conditions,’ Die Zeit said in an e-mailed release today, without saying where it obtained the information.”

Let me give three reasons why this idea is as silly as it is irrelevant:

  • First, the EFSF does not have the funding to finance a transaction large enough to make a difference. To preserve its eurobonds’ triple-A rating, it must use its €440 billion war chest of guarantees to lend only €250 billion. Of that about €100 billion have been set aside for Ireland. Given that it must remain capable of taking under its wings Portugal and Spain, even if Mrs Merkel were to agree to increase its lending capacity back to the original €440 billion (which is the red line beyond which no German government will never tread), there is simply not enough money to lend to Greece for the stated purposes.
  • Secondly, even if the EFSF were given the funds to lend to Greece, the buy-back operation is bound to fail. Why? Because the only sense in buying you own bonds back is if you can convince the markets that you will not be able to meet your obligations when they mature. And here lies the rub: If the EFSF does not lend sufficient money to Greece for the buy-back, the buy-back will not make a dent into the Greek debt problem. Conversely, if the EFSF doeslend Greece ample funds, the banks will not sell at sufficiently low prices (for the buy-back to make a difference), expecting higher future payments from a well endowed Greek government. Heads the buy-back does not go ahead, tails the buy-back is meaningless.
  • Thirdly, everyone knows that Greece is the canary in the mine; that the debt crisis concerns the way in which the debt burden of one eurozone country inflames the debt crisis of the next, until even France is not left unscathed. Thus, a small dent in the Greek debt will make no difference to the overall problem plaguing the eurozone. For this reason, and given that European leaders seem to have, at long last, realised that a comprehensive solution is necessary, the EU will not give more than a passing glance at this buy-back of Greek debt scheme.

To conclude, buying back one’s own debt happens all the time. Italy, France, Belgium, corporations in the four corners of the globe, all occasionally resort to borrowing money for the purposes of buying their own bonds. When do they do so? When they find that the interest rates of the new loans are low enough relative to the price at which their old bonds are trading. To make sense, these occasional forays into buying one’s own debt are worth the trouble only when the indebted entity is reasonable solvent, does not find itself pinned under a mountain of debt, and can exploit short run falls in its bond values at a time when it can, for some serendipitous reason, borrow at low interest rates.

Alas, Greece is not in this game, as it has been frozen out of the markets some time ago. Snowed under an avalanche of debt, watched over by its debtors like a high security prisoner, and unable to access loans at reasonable interest rates, buying its debt back makes no sense whatsoever. If it were to be given public money for the purpose, e.g. by the EFSF, the gains it can expect are marginal. In my estimation, it could not buy back more than €12 billion (of its €300 billion-plus old bonds) without annulling any of the buy-back’s benefits. And what would Greece benefit from buying back this amount of debt at the likely rates and prices? No more than €1 billion in total. Is this prospect worth wasting grey matter on?

Of course, things would be different if the EFSF were to buy Greek bonds itself and sell them to Greece at a major discount. But that would cost the EFSF a great deal of money, push the price of Greek bonds sky high and ensure that the eurozone cannot rationally attack its overall debt problem (as a similarly generous buy back scheme would be impossible to effect for Ireland, Portugal and Spain).

So, could a buy-back happen? Perhaps, if a comprehensive solution is found that arrests the euro crisis, and peripheral spreads fall substantially, Greece may then manage to buy back, and retire, a small amount of its remaing debt. For instance, if our Modest Proposal is adopted, and the ECB takes on its books tout court member-states’ bonds equivalent to 60% of GDP (the Maastricht-compliant eurozone debt), then spreads will collapse and Greece (the only country left with a debt above the Maastricht 60% of GDP limit) could be helped by the EFSF to retire part of its remaining debt.

In short, until a comprehensive solution to the euro crisis is agreed upon, one that does not rely on market operations, voluntary haircuts or toxic eurobonds, the rumours about an EFSF-funded Greek debt buy-back deserve a scornful response, if not out-and-out contempt.

7 Comments

  • The Germans are engaged on a never ending fantasy, that they can exercise power without committment, yet it may ‘work’. Of course, if logic were the criterion, the scheme of buy-back would be laughable, debt management is the routine job of the relevant agency and it is not just fiscal, in fact – when done properly – it is profoundly part of monetary policy. But logic is not the criterion, the whole matter rather belongs to the field of rhetoric. The apparently strongest player is in fact the weakest because it has to conduct policy on the sly, the fear of the people roused to stupor is more active before irrelevant elections [though it is likely that the Germans actually do not know what they are doing and what relation this has with what they are pretending to do]. But, yet again, our own beloved country may somewhat benefit from this internal German play-within-the-play, in that, absurdly, spreads may fall – while simultaneously nullifying the aim of the pretend game. A good posting.

    • If it were just a matter of Greece bearing debts, the German shadow play could work. But it is not. Ireland is boiling over. Portugal is engaged in its own little game of chicken with markets. Spain is on the verge. It will take a lot more than theatrics to deal with this crisis. Or so I fear…

  • Prof. Varoufakis,

    I still don’t see any evidence of your Modest Proposal in the EC gossip that I read. It seems that euro-zone policy makers are focused on policies that would be consistent with the upcoming ESM. For example, the most recent leak completely ignores your idea and fails to address your criticisms:

    Financing of buy back operations

    Instead of taking the beneficiary Member State fully out of the market for a few years, the financial support could also in some cases be used fully or partly to finance a buy back operation. The beneficiary could buy back its own debt using ESM funding on the secondary market, at market prices (with a small premium, so as to create an incentive for bondholders to participate in the operation). This would allow the beneficiary MS to reduce significantly its stock of debt and should therefore improve its market access, by alleviating the fears on the debt sustainability.

    • Dear Mark, It is not necessarily a bad thing that the Proposal is not in the news much. Most of the proposals that are exposed to the light of publicity and rumour get somewhat burnt around the edges. But you are, of course, right in saying that the debate is showing no signs of moving on from the inane to the substantial. What I can tell you in that the Modest Proposal has been studied (and largely adopted) by the Finance Minister of Italy, ex Prime Minister Amato and, of course, by the ETUC (the European Trades Union Council). Additionally, it has been brought to the attention of the Chair of the Eurogroup, Luxembourg’s PM (who has co-signed with the Italian Minister of Finance a proposal for eurobonds very similar to the one in the Modest Proposal). The Greek PM is quietly sympathetic while Jaques Delors is following the Modest Proposal’s progress with sympathy. Nevertheless, the key to all this is Germany: It has not yet decided whether it wants to end the crisis now or to allow it to drag on in a quasi-controlled manner that suits its objective of excercising increasing power without committing to a eurozone from which Germany can no longer leave. Unitl they decide to binds themselves to the eurozone permanently and unequivocally, the crisis will drag on and all sorts of silly ideas will be aired. Regarding you point about buy back schemes, here is my reply: It would be perfectly possible to use the Centre’s funds to relieve the periphery of a substantial part of its debt (e.g. by having the EFSM/ESM buy Greek and Irish bonds and then swap them with freshly mminted Greek and Irish bonds of a smaller face value), so as to allow countries like Greece, Ireland etc. to return to the money markets. The problem with this solution is twofold: First, it would cost an arm and a leg to do that (compared to the Modest Proposal’s suggestion that a large part of existing debt is transferred, not sold, tout court to the ECB – which, in turn issues its own eurobonds for the purpose). Secondly, it lacks a developmental or future growth potential (unlike our Proposal’s third plank which allows member states to utilise the proposed eurobonds in order to part-finance EIB funded large-scale developmental projects).

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