European investors and politicians prodding Greece to restructure its debt may end up wishing they hadn’t.
Talk of restructuring spurred by Germany risks re-igniting Europe’s debt crisis, enveloping Spain just weeks after European leaders said bailouts of Greece, Ireland and Portugal ended contagion. Under a Greek default, Europe’s financial system would strain as banks in and outside Greece and holders of Greek bonds, such as the European Central Bank and domestic pension funds, tally losses.
“By restructuring Greek debt you also may precipitate a crisis in Spain,” David Watts, a strategist at CreditSights Inc. in London, said in a telephone interview. “At that point it doesn’t matter how much you’ve saved by restructuring Greece, the fallout from Spain is much greater. The issue comes back to not knowing the ultimate cost.”
Speculation by German officials that Greece may run out of alternatives to restructuring underscores their reluctance to spend more on bailouts, while ignoring precedent. Sovereign financial crises usually don’t come in isolation. Thailand’s 1997 devaluation triggered the Asian crisis, Russia’s 1998 default set off a global financial pandemic and Latin America required the U.S. to develop Brady bonds as a virtual guarantee.
The euro had its steepest decline in almost four months yesterday and Greek and Portuguese bonds tumbled today, sending risk premiums to euro-era records as default speculation mounted. Otto Fricke, the parliamentary budget spokesman for Chancellor Angela Merkel’s Free Democratic coalition ally, said in an interview that Greece may not make it through the summer.
Such comments “signal a loss of patience” that makes rash action more likely and risks “a Lehman-style chain reaction to a potential Greek default,” Holger Schmieding, London-based chief economist at Joh. Berenberg Gossler & Co., said in a research note. “The contagion risks are still far too serious” as Spain and Ireland need more time to turn their fiscal positions around.
Germany, the biggest country contributor to Europe’s bailouts, stoked the debt debate last week, after backing an EU accord in March to ease Greece’s repayment terms as its economy shrinks under savings measures imposed as a condition for aid.
Restructuring Greek debt “would not be a disaster,” Deputy Foreign Minister Werner Hoyer said in an interview on April 15. Finance Minister Wolfgang Schaeuble mentioned “voluntary restructuring” in a German newspaper interview.
While Schaeuble didn’t elaborate, German financial companies, led by Deutsche Bank AG, agreed after the bailout last May to help Greece by refinancing maturing Greek bonds and maintaining existing credit lines.
French and German lenders accounted for almost two-thirds of lending to Greek public and private debtors as of Sept. 30, according to the Bank for International Settlements. French banks held $59.4 billion and German banks $40.3 billion, followed by U.K. and Portuguese lenders to Greece.
European central bankers have also pushed back against Germany after the ECB bought an estimated 76 billion euros ($108 billion) in bonds to try to stem the crisis. ECB President Jean-Claude Trichet was thwarted by European Union leaders who rejected his bid to shift the bond-purchase program to the EU’s 440 billion-euro European Financial Stability Facility.
ECB Governing Council member Ewald Nowotny said in an April 16 interview there’s “no need” for restructuring and such a step might have “negative side-effects on the banking system both in the country concerned and in other countries.”
Greek Budget Cuts
Greece rejects any talk of restructuring as it enacts budget cuts demanded as a condition for the 110 billion-euro lifeline from the EU and International Monetary Fund. Even after Prime Minister George Papandreou announced 76 billion euros of austerity measures last week, Greece sold 1.625 billion euros of 13-week Treasury bills today at a yield of 4.1 percent, compared with 3.85 percent at the last such sale on Feb. 15.
“Market fears are premature,” said Georg Grodzki, head of credit research at Legal & General in London. “There is no incentive for Greece to restructure in the very near term while still working through its adjustment program, and there is no need to because it’s still funded by the EU and IMF.”
Markets underscore investors’ diminishing expectations for getting repaid even as the government is funded by international aid. Greek 10-year debt trades for 60 cents and yields 14.3 percent, more than 11 percentage points higher than benchmark German bunds. Two-year Greek yields soared above 20 percent and credit-default swaps signal a 65.8 percent chance of default within five years, 1.3 percentage points higher than yesterday.
‘Softening the Ground’
Without tipping its hand, Germany’s aim may be something less than a full-blown restructuring that forces investors to write off Greek debt. Merkel and Schaeuble “may be softening the ground” for extending maturities on Greek bonds before German elections in 2013, Deutsche Bank AG analysts led by Chief Economist Thomas Mayer said in a note.
Even that scenario “could be costly” by forcing German banks to adjust the value of their holdings. Encouraging investors to roll over their bonds while having the EFSF buy Greek bonds in the primary market next year may be the best option for policy makers, the Deutsche Bank team said.
“From the French and German perspective it’s not clear that the benefits of restructuring Greece outweigh the costs,” CreditSights’ Watts said. “You have to take into account that German and French banks are among the most exposed to Greece.”
Greece holds a trump card of its own. The government could reschedule unilaterally debt totaling about 340 billion euros since “the bonds in question were issued under Greek law,” Philip Wood, a partner at Allen & Overy in London, said by phone.
“What’s going on is a high-stakes game of poker between Greece, the EU authorities and the capital markets,” he said. “Both sides have very strong cards and the game will be very long and very serious. The whole of EU prestige is being tested, challenged.”