Germany may fund Greece for three years; the question is why

I am at a conference all day and will probably do a spot on BNN late this afternoon, so blogging will be limited. But I wanted to alert you to my thinking on some of the latest developments on Greece.

Apparently, Germany is now planning to make loans for Greece not just for 2010, but for 2011 and 2012 as well. This is a sea change in German thinking and is having a positive effect on all markets, with spreads on Greek debt and Greek sovereign CDS both coming in.  I believe this indicates Angela Merkel understands the gravity of the situation and the impact a Greek default would have on Germany.

Yesterday, I noted that the Germans are now talking publicly about German bank exposure to Greek sovereign debt. And earlier today Yves Q. Smith noted that a Greek default would be a catastrophic loss for the lenders. She quotes from the S&P’s press release on their downgrade of Greek debt to junk:

The outlook is negative. At the same time, we assigned a recovery rating of ‘4′ to Greece’s debt issues, indicating our expectation of “average” (30%-50%) recovery for debtholders in the event of a debt restructuring or payment default”

Now, we know that the German Landesbanks probably have a shed load of Greek debt on their books.  Moreover, the state of their capital base is very precarious indeed.  Think back to early last year when we were not discussing the potential impairment of Greek debt, but of losses related to US subprime and commercial real estate more generally. The Telegraph wrote a sensationalist story based on some leaked documents about the fragility of European banks. The details may be suspect but directionally, this is the real problem.

They wrote:

European bank bail-out could push EU into crisis
A bail-out of the toxic assets held by European banks’ could plunge the European Union into crisis, according to a confidential Brussels document.

“Estimates of total expected asset write-downs suggest that the budgetary costs – actual and contingent – of asset relief could be very large both in absolute terms and relative to GDP in member states,” the EC document, seen by The Daily Telegraph, cautioned.

“It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems.”

The secret 17-page paper was discussed by finance ministers, including the Chancellor Alistair Darling on Tuesday.

Are European banks sitting on 16.3 trillion in toxic assets?, Credit Writedowns

So, this seems to be the impetus behind Germany’s recent moves: it is well aware of the toxic assets still on its banks’ books. The government wants to put an end to the funding problem for Greece which is really a liquidity crisis in order to buy time to protect its undercapitalised banking sector.  At present, it seems they are looking to force their banks to take a haircut on Greek debt via a voluntary restructuring.

However, Marshall Auerback has said:

There’s another point. Greece seems ready to "restructure", which I take to mean that the banks will take haircuts on Greek debt as there will be pricing transparency.

If Greece defaults, you can do extend and pretend – "well, we can’t pay now, but we’ll do so when we get this bailout", which effectively preserves the illusion. So the restructuring course is potentially more destabilising to the European banking system.

So, it is still far from clear what the best course of action is for the Eurozone.  From a political perspective, European cohesion is desirable. But the way the Eurozone as presently structured is unworkable. The best we can hope for is a patch to fix the immediate liquidity problems followed by more thorough-going structural reform in Europe’s monetary experiment.

  1. Matt Stiles says

    Die Deutsche muessen aufpassen.

    They, themselves, have a large debt burden. However, it is not nearly as severe a problem because consumer indebtedness is lower, keeping the borrowing costs lower (similar situation to Italy in this regard – higher percentage of domestic ownership for sovereign liabilities).

    But if it is perceived that Germany will become liable for PIIGS debt, their borrowing costs will rise in turn. They are simply substituting a PIIGS funding problem for a German one, just as we have attempted to substitute a private debt market problem for a public one.

    Moving the liabilities around does not solve anything. And it seems the German populace are smart enough to figure this out.

    Debt deflation will have its day – one way or another.

  2. Jack says

    Greece is not going to be able to pay back any bailout loans they get. The Greeks have a structural problem, the public unions. The Greeks aren’t going to give that up easily. Default and leaving the Euro is in their future. It is only a question of when. The German people get it.

  3. Michael Jung says

    Google News is great for ‘looking back’ what others ‘said’ back in Feb 2009!,1518,608985,00.html

    “The concession was tantamount to a complete reversal. Until Monday, not a single representative of the euro zone had been willing to discuss the possibility of aid measures for countries in dire financial straits. Instead they have pointed to the Maastricht Treaty, which provides the foundations for the common currency. The treaty prohibits the community of states from providing financial aid to individual euro zone members. Each government is required to keep its own finances in order so that no country becomes dependent on another.

    But now Steinmeier is creating the impression that some euro zone members may ultimately require the same kind of bailout already seen in the banking industry and manufacturing. It could come at the cost of billions to taxpayers. “The euro-region treaties don’t foresee any help for insolvent countries, but in reality the other states would have to rescue those running into difficulty,” Steinbrück said.

    The consequences could be disastrous — not only for individual countries, but also for the euro zone in its entirety. “As deficits and debt rise rapidly and financial sector rescue packages increase contingent liabilities, market concerns about sustainable fiscal development surface, reflected in sharply risen spreads on sovereign bonds,” the study further states.

    “German Finance Minister Peer Steinbrueck became the first senior policy maker to broach the topic earlier this week, saying some of the 16 euro nations are “getting into difficulties” and may need help. He went further today, saying Germany would show its “ability to act.” French officials are also concerned about market tensions as the cost of insuring Irish, Greek and Spanish debt against default rises to records and bond spreads widen.”

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