More money, more problems?

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Would You Lend Greece $60 Billion?

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Keeping Greece within the euro zone and the European Union is a political question. Yet it's also about money, and it may be worthwhile to consider how Europe would act if it were a bank confronted with a big delinquent debtor. 

QuickTake Greece's Fiscal Odyssey

This would be an easy question to answer if the choice were merely between a Greek default on all of its debt and a write-off of some portion. Something is better than nothing. Yet the situation is more complicated: Greece wants 53.5 billion euros (almost $60 billion) over the next three years. Would a banker lend that sum to retain a chance of hanging on to some of the money already invested?

Calculating how much European countries would lose if Greece were cut off is not straightforward. They are seriously exposed to Greece in four ways: through straight bilateral loans issued as part of the first bailout in 2010, through guarantees on loans issued by the European Financial Stability Facility and the EU bailout fund, through the European Central Bank's holdings of Greek bonds and through Target2, the ECB's settlement system in which all euro members have outstanding claims on Greece. 

Deutsche Bank

It's doubtful that the Target2 claims, a total of 100.3 billion euros, should even be part of the equation. Four non-euro countries, Bulgaria, Denmark, Poland and Romania, are part of the system, and even if it drops the currency, Greece will still do a lot of trading in euros. Besides, part of that exposure is collateralized. A banker would only worry about the rest of the debts, 211 billion euros at face value.

A Greek default on the bilateral loans would mean a straight loss to the creditor nations, but it would fall under the classic definition of sunk cost: The countries wouldn't have to plug a hole in any balance sheet by borrowing more, they'd just never get back their 52.9 billion euros. That would be painful, but the payments are spread over 22 years, starting in 2020, and the interest rate is just 50 basis points more than the 3-month Euribor rate, which is in negative territory right now. The loans are basically interest-free. At a 2 percent discount rate, the present value of the repayments would be about 40 billion euros.

The EFSF loans also are practically interest-free, with repayments spread over 32 years, starting in 2023. The fund would probably call in its members' guarantees if Greece defaulted -- though that wouldn't happen until the first payments were due. Most countries would need to issue new debt to cover the guarantees, a whopping 130.9 billion euro exposure, but in present value terms, it amounts to less than 100 billion. Besides, the guarantees are already accounted for in the European countries' debt levels.

The only payments Europeans should worry about now are the ones due on bonds owned by the ECB. The total amount Greece owes is 27.2 billion euros, with 4.4 billion coming due in July and August 2015, and most of the rest scheduled to be repaid in 2017 and 2019. If Greece defaults, however, the ECB probably won't even need to make any capital calls on euro countries' central banks. RBC Capital Markets said recently that the ECB's own loss absorption capacity was 36.3 billion euros at the end of last year, and the euro system's is at about 500 billion now, dwarfing the Greek debt.

In total, the potential losses from a massive Greek default appear to outweigh the pain of investing another 53.5 billion euros over the next three years. Not counting the ECB and Target2 exposures, Europe would be looking at a present-value loss of 140 billion euros. If it behaved like a bank, Europe would be tempted to lend more money to help Greece get back on its feet and repay the huge debt.

The problem, however, is that Greece also wants debt restructuring, ideally a write-off, and it has plenty of backers, including the International Monetary Fund, which considers the current burden unsustainable. It's anybody's guess how the forgiveness might be structured, but if half of the existing debt's present value is snipped off, the decision for EU-as-bank becomes trickier. What if Greece is still unable to start paying off the old loans after a few years and the third bailout is just added to the mountain of debt that can never be honored? It would become a matter of trust between lender and borrower.

The banker would be tempted to offer partial debt relief, but no further loans. Why throw good money after bad? For the bank's shareholders -- in this case, EU countries -- it would also be easier to accept a sunk cost than to justify fresh spending with uncertain results. It's difficult to say, however, how much such a solution might help Greece, given that most of the debt in question is backloaded and isn't a burden for the Greek government today. If it were just a debtor, not a sovereign, it would be tempted simply to default on all its debts and start from scratch.

So it's conceivable that a bank would just kick the can down the road and approve the new loan just to avoid immediate write-offs. Given all the political implications of a Greek euro exit and European politicians' crisis fatigue -- no one has been able to go on vacation this year because of the Greek talks! -- such an outcome is the likeliest, too.

As with a loss-averse bank, however, the day of reckoning will eventually come. It's hard to believe that the government of Prime Minister Alexis Tsipras, which has accepted the creditors' austerity demands to secure more money, will be good at implementing a program so far removed from the one with which it came to power, and that Greeks will have much patience for its experiments. It may be possible to avoid disaster for a year or two, but the economist Paul Krugman shows that there is a better case for Grexit than the one Tsipras makes for an extension of the country's self-torture.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Max Berley at mberley@bloomberg.net