Ways of Treading Water II: Eupdate Greece

A year ago, back when the Greek government debt crisis officially became the Eurozone gestalt crisis, I speculated that Greece would not launch a debt restructuring any time soon.  I hereby officially change course.  There may well be a restructuring, and it will do no one any good.  I am skeptical not because I thought then, or think now, that Greece is solvent.  I had and have no idea, though Greek debt numbers look worrisome by most conventional metrics.  Rather, I am skeptical because the dominant proposal on the table--a lengthening of maturities with no net present value reduction (a "light dusting")--does precisely what EU politicians can do and have done perfectly all by themselves:  Tread Water.

To be sure, there are elegant legal ways about it, which will be matched by investment bankers doing their own elegant thing--but both need a theory of the case.  If Greece is insolvent, reduce the debt and recapitalize the banks that hold it.  If it is illiquid, keep giving it EU/IMF Lender of Last Resort money.  Is it really the Finns?

For all its light benefits, a light dusting would come with nontrivial institutional costs:  for one, getting central banks formally involved in a debt restructuring.  This is not just about the European Central Bank, which bought quite a bit of Greek government debt from the banks since the start of the crisis.  Other central banks hold Greek debt in their Euro-denominated hard currency reserves.  Contrast Uruguay, cited as the inspiration for the light dusting scenario:  who counted Uruguay's U.S. dollar-denominated debt as part of their hard currency reserves?

Somewhat apart from it all is the peculiar matter of credit default swaps (CDS) on Greek sovereign debt.  Their overall volume has been tiny, yet the market-policy rumor mill is sounding as if the entire restructuring decision hinges on avoiding CDS triggers.  Under the prevailing definition of credit events, it means avoiding a restructuring that is "binding on all" of Greece's bondholders (yes, Virginia, this includes but is not limited to collective action clauses).  The options are either a truly voluntary yet general restructuring (Felix Salmon is skeptical), or some serious casuistry.  Bottom line:  a Greek restructuring will Tread Water in form and substance alike.

But why do we care so much about the small batch of Greek CDS?  Is it because someone important stands to lose?  Greek banks lose either way, since they are the dominant holders of their government's debt.  If Greek banks also sold protection on their government (compare Russian banks in the run-up to the 1998 crisis), they will either default, or will add the cost to the government's recapitalization tab.  In this sense, it was just free fee income-turned-Treading Water.  But if not Greek banks, then who?

Comments

[RebelEconomist]

On the contrary, I suspect that, if the European authorities are keen to avoid CDS triggers, it is because someone important (to them) stands to win: speculators!

I like the treading water analogy.

[Athenian]

The Greek situation is under control. Solution: term extension for short term debt, lower interest and no hair-cuts for bond holders. Result: return to capital markets ASAP.

The "reprofiling" of Uruguay's bonds involved a five-year extension of the maturity date of each instrument. Coupons were kept the same. There was no haircut to principal. So basically the transaction just shifted the country's debt profile out by five years.

Did the fact of this debt restructuring keep Uruguay out of the international capital markets? Yes. For precisely 31 days.