On Central Banker opposition to a Greek restructuring
Yesterday I was on BNN’s Headline with Philip Coggan of the Economist and presenter Howard Green. The issue of greatest importance that we discussed yesterday was Greece.
Last week, German Finance Minister Wolfgang Schaeuble indicated readiness to accept a soft restructuring and bond exchange which would defer interest payments on Greek sovereign debt. He sent a letter to colleagues in the euro countries indicating this. However, since that time, central bankers have expressed disquiet over this policy approach. Yesterday, ahead of our chat, Mario Draghi, the head of the Italian central bank and likely next European central bank head, rejected this idea in very strong language saying, explaining that “the ECB is not in favour or restructuring and haircuts” and that it “excludes all concepts that are not purely voluntary.”
For now then, it seems a soft restructuring is off the table. Nevertheless, market participants are uniform in their belief that Greece will restructure. And Greek bond yields have soared on the back of this expectation. Moreover, contagion has seen all of the euro zone periphery suffer with CDS and yields increasing in Spain, Portugal, Ireland and Italy. This is clearly unsustainable and I expect a definitive policy response in the next few days.
As a reminder, I posed the question “Can Greece CDS Trigger A European Lehman?”, answering yes and acknowledging the fears that Draghi and other central bankers have about a restructuring. Nevertheless, it is clear that the ECB and the other euro zone national central banks are not impartial due to their exposure to peripheral bonds and the potential for a loss of capital in the case of a euro zone sovereign default. The ECB is not conducting a stealth bailout through the euro zone Target2 payment system. However, national central banks do face a potential loss of capital based on their share of ECB capital and this creates a conflict of interest that makes the euro zone sovereign debt crisis even more tricky.
Europe needs to make a choice of a temporary bailout or immediate restructuring now because the backdrop to the Greek drama is worsening.
- Some Greek socialist MPs aree defecting away from the lanned ayusterity backed by the Greek government. There is a risk that the austerity plan will be rejected. As I write this, Greek workers are striking, with a major confrontation developing in the Syntagma Plaza. The situation is very bad with tear gas, Molotov cocktails, the whole nine yards. One financial journalist, Stacy Herbert, for example, has provided live commentary on twitter. This is a clear indication that austerity will be resisted in Greece and that a restructuring is inevitable.
- Contagion continues to spread. The Greek 2-year is yielding over 27% now. Not only are we seeing a selloff in peripheral CDS and bonds, we are also seeing downgrades on multiple fronts. S&P recently downgraded Greece to the world’s lowest sovereign credit rating at CCC, below Pakistan and Ecuador. A raft of Greek bank downgrades by S&P followed since they will be capital-impaired due to a Greek default. And a set of French bank downgrades (BNP Paribas, SocGen and Credit Agricole) by Moody’s also followed as these banks have heavy exposure to Greece. And there is always the opaque CDS market.
While I acknowledge the real fears that central bankers have about the impact of a restructuring, this political dithering is making matters considerably worse. Clearly, burden sharing is needed and that means bondholders will have to take haircuts. Like the Greek government, the Irish government, under pressure from central bankers and Timothy Geithner, has heaped all of the burden onto taxpayers (pointer to Kevin O’Rourke). This should not and cannot last.
(Click on the image of Howard Green below for the BNN videos. We also discussed US monetary policy and China.)
If the bondholders via the central banks continue to pressure taxpayers to avoid default at all cost then a riots in Greece and total default will be the only outcome. That will punish the bankers and politicians who backed them. I suspect that we will have a series of such defaults before the crisis is over. I cant see the politicians being able to get away with kicking the can down the road forever and taxpayers will not tolerate their standards of living declining forever.
What I don´t understand in all of this is the strong opposition in Greece to the bailouts. Obviously, I understand that people don´t want austerity, but I don´t see any real alternative (IMHO a unilateral default or a departure from the euro would also imply austerity, unless they take the hyperinflation road).
What exactly do the people demonstrating want?
That the UE and the IMF (taxpayers of other countries) continue to lend them money at below market rates without asking for austerity in return? For their debt to continue growing?
I even think that the UE and the IMF could do that (maybe they should, I don´t know) but the idea of the Greeks demanding it as if it were some kind of God-given right and holding cute UE=swastika flags just doesn´t feel right. And I am not even German.
I think part of this greek attitude comes from the idea that the bailouts are for the bankers, and not for the Greek people. Of course it is true (and infuriating) that this is a bailout for the bankers, but isn´t it true that it is also a real bailout for Greece and its people?
A default will be a lot better for the Greeks. The problem is that even if they wanted to borrow now they would have to pay rates of more than 25%. If they default they can eliminate the deficit considerably, since much will be interest. Even if they were forced out of the Euro to the drachma it will mean that they can devalue the currency and let the currency take the strain of devaluation, rather than the people. The problem is that the central bankers are opposed to this because it would mean that their banks would be hit directly from losses on bonds, and even more to huge payouts on credit default swaps. The whole objective is to kick the can down the road and hope that the banks are strong enough to survive the inevitable impact of a default in two or three years time. Though that belief is also misguided because it assumes that they do not have any other problems on their balance sheets. Since many countries have had credit inflated asset bubbles these are also unsustainable as a result of austerity. So they are trying to keep the rich rich and let the rest pay for their mistakes.