Greek default and Greek debt restructuring in 2012

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Greece has been at the epicenter of the crisis in Europe, ever since May 2010 when the country lost market access and received the first bailout, worth 110 billion euro, under the troika (EU-IMF-ECB) programme. Though the crisis in Europe is systemic, i.e. it is caused by the structural flaws of the euro architecture and the malignancies of the European banking sector, coupled with the ill advised policies exercised at national and supranational levels; Greece is considered by many as one of the main sources of trouble in Europe. The country, which accounts for approximately 2% of aggregate Eurozone GDP, is seen as the “Lehman Brothers” of Europe, as the entity that has to be bailed out at all costs in order to avoid a “calamitous” domino effect that will see a series of bank failures across major European economies and will provide the grounds for further uncertainty regarding the capacity of the EU to deal with its own issues. Based on the entirely wrong assumption that a default of Greece would reverberate across the globe with unpleasant results for everyone, policy-makers considered it wise to use productive resources to prevent the natural failure from occurring.

The debt of Greece always was unsustainable, while the malignant structure of the Greek economy meant that the original bailout would never be enough to prevent the eventual bankruptcy. A few months ago a second bailout to Greece was agreed upon, worth 130 billion euro, under the condition that the country would be able to reach an agreement with its private creditors over imposing on them “voluntary” haircuts, under the Private Sector Involvement programme, to restructure its debt in order to make it sustainable and controllable.

The PSI programme has been from the outset an ill advised policy, designed by politicians who think that they can bend reality and shape the world in any way they like, without any cost. It first requires from bankrupt Greece to negotiate with its private creditors, within a framework that is clearly in favor of the latter. Greece is in a very weak bargaining position, first because it cannot exercise its sovereignty by imposing coercive haircuts, second because it is in desperate need of the second bailout. On the other hand private creditors, private banks to be more precise, have enjoyed the state-sponsored/taxpayer-funded support under massive bailouts, “liquidity injections”, the latest LTRO programme of the ECB and others, which provides them with much negotiating power to restructure the debt of Greece in a manner that serves them well.

In addition the PSI has an external character that does more harm than good. It adds another layer to the way regulators and markets act, by introducing the notion of “voluntarism” in a state’s debt restructuring. Under the term “voluntary” policy-makers play with words to avoid the activation of the CDS (Credit Default Swaps) contracts, that normally consider a debt restructuring as a “credit event”, i.e. as an event that activates the payment of the contract. This distortion of the natural checks and balances that the market has produced to estimate risk creates policy uncertainty. In other words it makes investors skeptical both of the effectiveness of the CDS and of the actual risk sovereigns have. This is in my view a major of source of uncertainty which effectively restrains investment,as people do not know what other sort of alchemy will politicians resort to, to distort yet again the manner in which business is done.

Greece should have defaulted the moment it could no longer access the markets to receive loans. The road that bailouts pave is always filled with more debt, more ill-advised policies, further deterioration and a large-scale malinvestment which in the long-run will take revenge of the bad policies of the present. A default of Greece back then would have been much less severe than it will be today, since the systemic interconnections were less. Today a default of Greece will mean that the ECB will have to write down large amounts of sovereign bonds, effectively losing its credibility; Europe’s quasi-bankrupt banks will receive another hit, while all countries that contributed to the bailout fund will see their money evaporate. In short the interventionist bailout policy in general and in particular, has done much more harm than good, by producing a vicious cycle in which good resources, taxpayer money, is absorbed into bottomless black holes, without the crisis being effectively addressed.

No matter how the PSI programme will end up, the sovereign debt of Greece will still be unsustainable, while the structural malignancies of both the Greek economy and the euro architecture will continue to reinforce the negative dynamics. The European Union and the Eurozone in particular is dealing with a “popcorn effect”, i.e. it is not the fall of one entity that creates uncertainty about the other, but it is the deep lack of trust in the whole system to cope with the challenges it faces that lies at the heart of the issue. The only real domino effect that Europeans have witnessed ever since the crisis first hit Europe, is one bad policy following the other, resulting in more ill advised decisions that create more uncertainty and produce adverse effects. The strategy of the EU towards Greece and itself has been wrong ever since the very beginning and things show that this cannot change easily, with whatever that may imply for the future of the single currency and the integrity of the union.