I believe that this article from Nouriel Roubini, at Project Sindicate, completes the post I previously wrote on the options for restructuring the (Greek) debt.
In it he argues that
” A full-blown official bailout of Greece’s public sector (by the International Monetary Fund, the European Central Bank, and the European Financial Stability Facility) would be the mother of all moral-hazard plays: extremely expensive and politically near-impossible, owing to resistance from core eurozone voters – starting with the Germans.”
Debt buybacks, in specific, “would be a massive waste of official resources, as the residual value of the debt increases as it is bought, benefiting creditors far more than the sovereign debtor”. (Although I would not necessarily agree with this I see the point. I post-pone a discussion of this issue for the next post)
After rejecting the French roll-over proposal due to the heavy costs it imposes on Greece, he then asks “how can debt relief be achieved for the sovereign without imposing massive losses on Greek banks and foreign banks holding Greek bonds?”
His answer is to “emulate the response to sovereign-debt crises in Uruguay, Pakistan, Ukraine, and many other emerging-market economies, where orderly exchange of old debt for new debt had three features: an identical face value (so-called “par” bonds); a long maturity (20-30 years); and interest set well below the currently unsustainable market rates – and close to or below the original coupon.”
He goes on to argue that
“The advantage of a par bond is that Greece’s creditors – banks, insurance companies, and pension funds – would be able and allowed to continue valuing their Greek bonds at 100 cents on the euro, thereby avoiding massive losses on their balance sheets. That, in turn, would sharply contain the risk of financial contagion.
“Rating agencies would consider this debt exchange a “credit event,” but only for a very short period – a matter of a few weeks. Consider Uruguay, whose rating was downgraded to “selective default” for two weeks while the exchange was occurring, and then was upgraded (though not to investment grade) when, thanks to the exchange’s success, its public debt became more sustainable. The ECB and creditor banks can live for two or three weeks with a temporary downgrade of Greece’s debt.“
This is all very good and well, but what if he is wrong? I understand that Mr Roubini comes with an extensive experience, and his reputation for Doom and Gloom mean that his optimism is even more appreciated. However I have three problems.
First, I am not sure that contagion could be stemmed. The past behaviour of EU member states has been characterised by an extreme willingness to come to the fore and offer their insights into what is going on, individually. Although transparency is a welcome feature of any polity, it is better enjoyed when it sheds light on efficient governance, rather than on confusing bickering. In order to get to the par restructuring that Mr Roubini advises, officials will have to discuss it, with each other and inevitably, publicly. How many days like friday 8 of July can the Eurozone take?
Secondly, what if the selective default rating lasted more than a mere “couple of weeks”? In the present context of uncertainty, this would require a level of concertation that the member states simply do not possess. I fear that the proposal is optimistic about the ability of European leaders to reach agreement in light of past disappointments. If for some reason the restructuring took too long (as one would expect in the EU environment of a war of attrition), uncertainty would spread as to whether what started as that nice, on par, restructuring wouldn’t be on its way to become a messy default. This would certainly lead to contagion, which in light of the recent events in Italy, is my main concern.
Finally, what if after the restructuring was complete, the rating agencies did not increase the ratings of Greece? The logic of Mr Roubini’s proposal is quite coherent. If you give the private sector a fair deal, as soon as that deal is clear, things should return to normal. If the rescheduling is well done, there are only two ways in which I can see this question being problematic. First, if the rating agencies simple make a mistake and for some arbitrary, incompetent, reason fail to spot this rescheduling as a good solution. The second, more unlikely, is that the rescheduling of Greece, Portugal, Ireland, Italy and Spain creates a liquidity crisis. That seems unlikely, but it is not impossible. Anyway, it could be easily fixed by the ECB.
In conclusion. Mr Roubini’s argument is very good. However, in the midst of the cacophonous European political debate, I fear that the markets will fail to see the forest for the trees and upon hearing the words restructuring will collapse en mass.