Merkel may force banks to take haircut on Greek debt

German Chancellor Angela Merkel is feeling pressure to force German banks to take a haircut on Greek debt by both her own party and opposition leaders (like Frank-Walter Steinmeier, the former Vice Chancellor and now head of the opposition in the Bundestag).  This is the first public indication that German politicians recognize that a Greek default would negatively impact the capital base of German domestic institutions which hold large amounts of Greek sovereign debt.

So, now the rhetoric is shifting away from one purely of austerity for Greece in return for aid to one in which Greece undergoes a voluntary restructuring. On Friday, in a post based on Marshall’s BNN interview, I mentioned three scenarios for Greece at this juncture.

  • In scenario one, you eject Greece from the Eurozone, they devalue their currency and, after a turbulent period, they are on the road to recovery.
  • Outcome number two is to depreciate the Euro, of course. The Euro is dropping as we speak.  But, I am talking about a more serious decline. As I recall, the Euro dipped to as low as 83 cents during Robert Rubin’s strong dollar policy days.  If the EU structures the bailout in the right way (fully backstops the period of increasing debt to to GDP) and floods each country with liquidity (aka prints money), you are sure to get this kind of outcome. Everyone gets a massive boost to competitiveness. Problem solved.
  • Neither of these scenarios is particularly palatable as they are likely to increase already mounting trade friction.  The other Edward mentions the only other viable alternative: a restructuring or default.

So, where there has been a lot of political posturing around scenario number one (or its analogue in Germany and a few core Europe countries leaving the euro), there has been little public discussion from policy makers about scenarios two and three. In the link in the last bullet above, The other Edward (European economist Edward Hugh) puts it in plain English.

At the same time, some sort of Greek default is now no longer simply a theoretical possibility among many others, indeed talk of the inevitability of some form of debt restructuring (albeit voluntary) grows with every passing day. Erik Nielsen European Economist with Goldman Sachs said this week he is expecting Greece to offer some sort of “voluntary debt-restructuring” to creditors over coming months, while JP Morgan issued a research note saying that while such restructuring may not be imminent, the move would make sense given that Greece could be seen as “the sovereign analogue of a ‘bad’ company with a bad capital structure”.

Restructuring is simply a polite word for default, with the difference that it is normally carried out by agreement. The most likely form of restructuring in the present context would be debt rescheduling, whereby short and medium-term debt is converted into a long-term version, as happened with the so-called “Brady bonds” devised by the US Treasury to resolve the debt difficulties of a number of Latin American countries in the late 1980s.

Two weeks ago, we were considering the options including True Fiscal Austerity (see Greece And The Potential Upside In An IMF Rescue). Yet, while Marc Chandler mentions raising the pension age to 67 without exception as part of a True Fiscal Austerity solution, few are talking about True Fiscal Austerity as a solution anymore. It’s now either a default or restructuring within the euro-zone or a break-up of the euro-zone (and default or currency devaluation). This is a signal that things have deteriorated significantly.

Also see Merkel Pressured to Make Banks Share Cost of Greek Bailout at Bloomberg.

  1. frankl says

    This is going to be very hard n the older folks resident in greece and will likely increase mortality amongst that group. Emigration of youth with credentials will also likely increase. Net, fewer greek residents in a decade.

    1. Edward Harrison says

      I think it will be hard, Frank. Greek standards of living are going to deteriorate. The question is by how much depending on how well-crafted the policy response is.

      The interesting bit is that mortality rates actually increase during downturns. I am looking for the recent article in the blogosphere talking about this but i can’t find it. What people have seen is that mortality rates actually decrease in downturns. There are lots of speculative reasons why but the bottom line is that this is at odds with conventional wisdom about hardship and depression leading to shortened lifespans. I found the article interesting, although I was sceptical about drawing conclusions (correlation versus causality).

      If I find the article I will post it.

    2. Edward Harrison says

      Here is the article on life expectancy and downturns: The real reason Swedes live longer

      1. frankl says

        yeah i saw that, but i bet the combination of seeing one’s progeny/nieces/nephews leave while simultaneously having to work longer (or go back to work in one’s sixties) does not portend well for one’s seventies….esp since i don’t think most of the oldsters will qualify for the engaging/challenging/intellectually-rewarding….hmm? think manual labour and enervating tasks, not blogging or web-design eh? Still, poor population expectations will not be supportive for bond ownership, right? What a mess.

  2. Scott says

    Edward, why is devaluation such a non starter? You say it is because of trade tensions. With whom? Aren’t such tensions manageable? Isn’t a bigger problem the anathema of devaluation to the Germans et al?

    1. Edward Harrison says

      The Germans won’t go for euro depreciation. They want a strong Euro because that is the source of the German economic miracle.

      1. Michael Jung says

        On the same line. Germany as export nation can’t compete globally in the long-run with weak Euro. In case the PIIGS situation worsens dramatically.

        It feels like 2007 all over again. The majority said about housing(/real estate) that ‘this is not a problem. This is just a blip, it won’t effect our economy.’ (US Case)

        And the Europeans said in the summer of 2008, that ‘this crisis won’t spread to our shores.’

        Have you all forgotten?

        Not only will the bailout (managed via KfW) worsen the debt situation for Germany (~ 100 Euros from each citizen), there is the transmission effect of higher interest rates for sovereign debt/debt in general for everyone. This is the coming of the 2nd wave, this time is different (Rogoff).

        Now (6-12months) it won’t be obvious, but interest rates for everyone will go up in the long-run (24-36 months). Not only will Germany have to take considerable austerity measures, but every ‘western’ nation with too much debt. Markets will make the rules, not politicians.

        Western nations hurt themselves in a competitive manner (vs east) with too much debt to serve, it takes room out for productive investments and tax cuts. Instead they have to pay astronomically amounts if interest payments.

        And with this all, inflation will pick up too.

        Summary (the next 3-5 years I can imagine):
        Weak, anaemic, no growth for the West (developed nations).
        No room for stimulus packages, instead austerity measures.
        High inflation linked to general high interest rates for everyone and surging demand by the East (BRIC) for resources (oil and metals).

        That is my broader world outlook with a thick paint brush.

      2. Marshall Auerback says

        They might not have a choice in the matter, Ed. Today’s reaction in the market place to the Greek “rescue” illustrates that this is neither a purely Greek problem, nor a PIIGS problem. It’s a euro problem. The Germans are also occupants in this roach motel. Their inability to recognise this (or, at the very least, acknowledge this honestly) is causing the problem to metastisize. It will eventually hit the core as well.

        1. Edward Harrison says

          Agreed. The Germans act as if they are not catastrophically exposed. They
          are. This a eurozone problem not a Greek one.

          And their continued intransigence is the major reason yields are exploding.
          The Germans are in a rhetorical cul-de-sac that ends in another deep

          Maybe someone can work a restructuring without contagion. I think not. And
          as long as they are pursuing policies which reduce demand, you can assume
          double dip.

          Sent from my mobile phone

          1. Marshall Auerback says

            We agree on this 100%

        2. Michael Jung says

          Their inability to recognise this (or, at the very least, acknowledge this honestly) is causing the problem to metastisize. It will eventually hit the core as well.

          @Marshall Auerback::
          So far, every Administration under Merkel sat things out to the last second.

          No good sign that things will calm down.

  3. Michael Jung says

    On a another ‘Have you all forgotten’ line;

    Peso Crisis;
    USA bailed out Mexico not only bc the USA would have had to deal with a large amount of illegal immigrants, … fact is that this was just a decoy.

    Who invested heavily in Mexico? It were private American Funds and Banks. Who advised Bill Clinton to do the bailout? His Economic Council. Who was on the Economic Council? Everyone who gets now a bad rap too.

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