EUROPEAN DIARY:Without a managed default on Greek debt, the country's bailout needs could overwhelm Europe
IT’S HALF-TIME, with the second half still to play tomorrow night. As talks culminate on a big new rescue deal for the euro zone, the sense of anticipation and apprehension around Brussels is palpable. Another fraught moment of truth looms.
A managed default on Greece’s debt is in train, banks are to be recapitalised, and the firepower of Europe’s bailout fund will be enlarged. But the stakes keep rising. Worries are growing about Italy, prompting French president Nicolas Sarkozy and German chancellor Angela Merkel to mete out an unsparing dressing down to Italian prime minister Silvio Berlusconi.
Sarkozy is said to have played bad cop, Merkel the good cop. A promise of fiscal and structural reform was duly extracted from Berlusconi. Whether the playboy premier can deliver will be pivotal for the euro zone. The truth is that hope is vested more in Italy’s political and economic establishment generally than in Berlusconi himself.
Brussels wants Italy to follow Spain down the road of grinding austerity. Although Madrid remains under exceptional pressure, it has so far managed to avoid bailout aid. That is the template for Rome, but success is not a given.
We have seen how promises of reform from Greece, Ireland and Portugal failed to avert disaster.
We’re in the thick of the crisis. At issue right now with Greece’s bondholders is whether they agree to enter a “voluntary” pact in which they would incur a loss of 50 per cent or more on their investment.
This is crucial. Anything other than a voluntary initiative would constitute a “credit event”, triggering payouts from insurance policies against default. A market panic would be likely, prompting yet more turmoil.
But will the bondholders – banks mostly – sign up? The EU powers believe they will, even though a 50 per cent “haircut” is a much bigger thing to demand than the 21 per cent loss agreed in July.
The authorities seem to be betting that the principle of enlightened self-interest will kick in. If they want to avoid a credit event they probably cannot impose losses compulsorily. They reckon, however, that it might not come to that in the end.
Force majeure may do it for them.
While you might not think so from the greedy deal-making that led to the financial crisis, bankers have a fiduciary duty not to trade recklessly. If that suggests no right-thinking banker would voluntarily accept a 50 per cent haircut on a sovereign bond, bigger questions are in play.
Is it in the banks’ overwhelming interest to see the Greek question settled for once and for all? Would they benefit appreciably if the relentless spiral of woe in the euro zone came to a halt? Would they gain if that helped avert a new global recession? A banker who answers yes to these questions might well be persuaded that the alternative course of allowing Greece to swing in the wind is altogether more risky.
Europe insists there will be no disorderly default on Greece’s debt, but the danger of that happening will increase radically if control is not asserted over its finances. That would be akin to a Lehman moment in Europe, with all its potential for economic and political chaos.
In this context, a new report on the sustainability of Greek national debt by the EU-IMF-ECB “troika” makes grim reading. It says Greece will need €252 billion in bailout aid by 2021 if the haircut is not increased, and possibly as much as €450 billion by 2027 in the event of a further economic shock.
These are impossible figures for EU leaders. Take note that the latter sum exceeds the totality of the €440 billion in euro-zone guarantees that lie behind Europe’s rescue fund. With the bailout bill for Greece after a 50 per cent loss estimated at €114 billion, it is clear where the political imperative lies.
It is thanks in part to the internal rules of the IMF that these questions have come to a head. The fund is not allowed to lend to a country whose financial outlook is uncertain over 12 months. It was this provision that led to the original talks on Greece’s second bailout, forcing the decision in July to seek private-sector involvement in the rescue effort.
As the Greek bailout ails, another big move is imminent.
A managed or orderly default is no straightforward thing, of course. Indeed, the hardliners in the ECB say the contagion risk is so great and so unpredictable as to render the notion null and void.
But these are risks that EU leaders are now prepared to take, albeit with a precautionary boost to the bailout fund and banks.
The alternative may be that Greece’s insatiable need for bailout aid overwhelms Europe – politically and financially – leading to catastrophe for the euro zone.
