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.

  1. 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.
  2. 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.)

contagioncredit default swapsdebt restructuringECBEuropeGreecemonetary policyprotestsovereign debt crisis