When French Folly and German Naiveté unite against Greek debt: Another sorry episode of how not to deal with a systemic crisis

28/06/2011 by

While crises are the laboratory of the future, the euro crisis is proving more like the alchemist’s lair. Back in November, the brilliant idea was touted, with considerable fanfare, of having the EFSF buy (at a discount) Greek and Irish bonds in the secondary market (in order to effect a non-default haircut). Despite the excitement it caused, that idea did not fly (for the same reason pigs find it hard to achieve the lift necessary to get airborne). The last few days of high drama, centred around Athens’ Parliament and beamed into homes the world over, seems to have spawned another grand scheme. This time, it has its origins in the French banks which have, in view of the calamity that will befall them if Greece defaults (and their Greek subsidiaries crash and burn), been spurred into a frenzy of mental activity. The result was an ambitious plan ‘voluntarily’ to roll over part of Greece’s debt. In short shrift, a meeting of about fifty, primarily, French and German banks was arranged in Rome, under the tutelage of Vittorio Grilli (head of the Italian Treasury and chair of the EU’s Economic and Financial Committee), to discuss the matter and reach a provisional agreement on its implementation. 

The initial idea, by the enterprising French bankers, is centred upon a roll over of 50% of Greek government bonds (GGBs) held by the banks. Put simply, upon maturity, the banks would use 50% of the proceeds from the Greek state (i.e. from the money Greece gets from the EU and the IMF) to buy fresh Greek 30 year bonds that include an interest rate consistent with what Greece currently pays to the  EU (around 6%) plus a possible premium linked to average future Greek growth. The question then becomes: Why on earth would they ‘want’ to take such a long term risk on a basketcase economy? The answer is twofold:

First, because the plan provides for insurance in the form of a kitty of high quality shares and securities into which the banks will plough another 20% of their proceeds from the maturing GGBs. The point of that fund is to provide a fund from which to draw in the event of a Greek default on the fresh 30 year bonds. Secondly, and much more importantly, because the new 30 year bonds that the banks will purchase will (Brady bond style) be shifted off their books and into some Special Vehicle. In other words, it will be as if  the banks have not lent that money to Greece when it comes to Basle III and European stress tests. In effect, they will be allowed to utilise their ECB credit line to borrow cheaply and lend dearly on the basis of a capitalisation ratio that ignores their continued, long term, exposure to Greek debt.

When this plan was taken to Rome, yesterday, the French added another ingredient to the mix hoping that it would make the proposal more palatable to their German counterparts: The ‘insurance’ kitty would be guaranteed by the EFSF and would contain EFSF bonds in such a manner as to give enough confidence that the kitty does provide participants with decent insurance against a Greek default. The German bankers, according to the Financial Times, liked the French proposal. In particular they loved the idea that their new Greek bonds would be both insured and off their books! What they did not like was the 30 year horizon suggested by the French. Labouring under the Keynesian anxiety that in the long run we are all dead, they counter-proposed a much shorter maturity (as short as 5  to 10 years).

Might this idea be the beginning of a successful transplantation to Europe of the Brady bond logic (which helped resolve the Latin American crisis in the late 1980s)? Under no circumstances! Let me explain why I think of the Rome meeting as a get together of French folly and German naiveté. My explanation comes in three parts:

  1. Looking at Greece’s debt in isolation, the fact of the matter is that the banks involved in the Rome meeting hold only about 43% of Greek debt. So, the proposal involves a roll over of less than 22% of Greece’s mountainous debt. Moreover, this roll over makes no difference whatsoever to Greece’s solvency position in view of the unforgiving fact that the new 30 year bonds will bear an interest rate of at least 5%. In short, the proposed scheme is attractive only to (a) the German, Dutch, Austrian and Finnish governments (who would now have to seek smaller bailout loans from their Parliaments) and (b) bankers who can have their cake and eat it. The ‘only’ non-beneficiaries are Greece and the stricken… eurozone.
  2. The question of whether such a deal will trigger an EOD (event of default) is up in the air. Most analysts fear that it would trigger such an EOD ,in which case it would defeat the purpose entirely (the purpose of the French plan being to avoid a default event).
  3. I left the worst for last: All this talk of what to do with the Greek debt must be seen against the background of Europe’s continued commitment to remain in denial of the simple truth that this is not a Greek debt crisis; that Greek debt is the tip of the iceberg. It is, I submit, inconceivable that the Greek debt can be dealt with while leaving the Irish, Portuguese etc. debt crises (as well as Europe’s Great Banking Conundrum) in abeyance hoping that they could go away magically. It only takes a second’s thought to come to the conclusion that schemes of this nature could not possibly address the systemic crisis at hand.

In short, the French have shown, once again, that they can run rings around their German, far more stolid, counterparts. Alas, on this particular occasion what we have is Parisian folly getting the better of gothic naiveté in a contest of faculties that packs no hope of resolving our deep, systemic crisis.

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