How Greece inadvertently ducked under the rollover bullet

Ilustration by Manos Symeonakis

When French President Nicolas Sarkozy announced two weeks ago that French banks had agreed to participate in a rollover of Greek debt, it seemed a rare moment of relief in the country’s strained efforts to tackle its fiscal crisis. “The idea is that we won’t let down Greece and that we’ll defend the euro, which is in the interest of us all,” said Sarkozy, reflecting a sense of purpose and unity that the European Union has often lacked over the last 18 months.

However, the French proposal — which we will come to — soared briefly on the wings of hope before crashing into the immovable obstacle of reality. Two days of talks between bankers and insurers last week led to the Paris blueprint largely being discarded. However, the rejection of the French scheme appears to have helped Greece dodge a debt bullet. The more experts scrutinized the French plan, the more they realized it was a seriously flawed proposal that would worsen Greece’s debt problems.

The French scheme was based on four key elements. Firstly, Greek bonds that are due to mature over the next three years (reportedly worth 30 billion euros) would be rolled over for 30 years. This was perhaps the only realistic part of the plan. It indicated the path private investors will have to follow if they are going to play a constructive role in helping Greece pay off some 350 billion euros of debt, which it clearly cannot do under the current conditions.

However, this positive element was countered by the other parts of the proposal. As has been reported, Greece would have to pay 30 percent of the value of the bonds in question, while the remaining 70 percent would be reinvested — 50 percent in 30-year bonds and 20 percent in AAA-rated bonds, probably from the European Financial Stability Facility (EFSF). Effectively this means that Greece would be buying insurance for its bondholders.

Furthermore, the interest rates suggested in the French proposal would be prohibitive for Greece, which already has a debt-to-GDP ratio of more than 140 percent. Under the scheme, interest rates would be linked to the country’s growth and would range from a minimum of about 5 percent to 8 percent. Although, The Wall Street Journal reported that analysts calculating a 2-percent annual growth rate for Greece over the next 30 years found that the annual cost of funds to Athens would total 10 percent. Given that Greece is currently paying about 5 percent interest for its EU-IMF bailout package, which many analysts believe is far too high, the numbers in the French scheme simply did not add up.

This is one of the reasons why the Financial Times’s banking editor Patrick Jenkins called the French plan “laughably self-serving.” The Wall Street Journal was equally blunt in its assessment in an article titled “Greece is about to get hosed.” It should be pointed out that French banks are more exposed to Greek bonds than lenders from any other country. According to Standard Life Investments, their exposure at the end of the fourth quarter of 2010 was 65 billion euros, compared to 59 billion euros for Greek banks and 40 billion for lenders in Germany. BNP Paribas has been identified as the biggest single holder of Greek debt outside Greece, with 5 billion euros.

There is a final problem to the French proposal, which is that it addressed only part of Greece’s outstanding debt, and as Jenkins pointed out in the FT: “it would leave the Greek authorities to find the money to either pay back the rest of the maturing bonds, or default — the very thing everyone is trying to avoid.”

After the announcement of the French scheme, Standard & Poor’s suggested that if Greece participated, it would be viewed as a “selective default.” It may the first case over the last couple of years of a ratings agency actually doing Greece a favor because it immediately caused jitters among European officials, particularly at the European Central Bank, who have until now rebuffed any suggestions of a Greek default. The knock-on effect was to make the bankers and insurers who met last week under the auspices of the Institute of International Finance (IIF) reconsider how they could play a part in alleviating Greece’s debt burden or protect themselves from a sudden default.

“Like all con games, structured finance works best when the people doing it believe in the con,” wrote Bloomberg News columnist Jonathan Weil. “In this instance, they clearly never did. Better to admit Greece can’t pay its debts and then deal with the problem, rather than delay the reckoning.”

As yet there is no broad public discussion about Greek defaulting but the change in direction at the IIF talks was telling. Once it was clear that the French rollover scheme was dead in the water, the discussion soon moved on to more comprehensive proposals. IIF Managing Director Charles Dallara said on Friday that discussions had broadened to “look at a range of techniques to reduce the stock of debt.“ This includes the possibility of buying back Greek debt, possibly via the EFSF, or switching existing bonds for ones with extended maturities, which could trigger a default. Dutch Finance Minister Jan Kees de Jager further emphasized the shift in thinking by saying that “a short and isolated rating event” would not be a “disaster.”

It is inevitable that the private sector will have to shoulder some of the weight of Greece’s debt load, especially since the same bondholders have profited from high yields in the past. But for such a solution to be reached, governments, including Greece’s — which remained largely passive on the rollover proposals — will have to adopt a more proactive stance. It will be interesting to see what eurozone finance ministers have to say on the subject when they meet on Monday.

The last couple of weeks have emphasized that if Sarkozy and Europe’s other decision-makers really want to avoid letting Greece down, while also defending the euro, they will have to come up with proposals that involve some sacrifice by more than just Greek and European taxpayers. It is a fine balance though, because Greece will eventually want to return to these lenders to borrow money. There are more bullets to be dodged.

Nick Malkoutzis

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