It’s time for the devastated nation to face reality. The only way out is to restructure now, with bondholders taking a 50% hit.
Europe should make Greece restructure its debt — swiftly. It would require delaying interest payments and an orderly reduction of the total debt by 50%. And with 327 billion euros outstanding, we don’t recommend this lightly. Usually, Barron’s staunchly advocates full repayment to bondholders. But the choice for Greece’s bondholders, as we see it, is to accept 50 cents on the euro now — or 30 cents or worse down the road. Failure to restructure will also bring further societal and economic ruin. With Greece’s unemployment rate at 15%, biding time until an eventual default could throw the country into depression, incite more unrest and drag all of Europe into deep recession. It could even cause Europe’s common currency, the euro, to unravel, and shake the foundations of the European Union itself. Except for a few brave European leaders who have whispered in recent weeks that Greece get debt relief, Europe’s official approach has been to muddle along and hope the problem will go away. It won’t.
Last week, in its latest Band-Aid attempt, the government announced new austerity measures that will extract a further €6.4 billion ($9.1 billion) from its reeling economy — through job and wage cuts, and new taxes — a desperate effort to make up for missed budget targets set in last year’s €110 billion bailout by the EU and International Monetary Fund. Not only are steps like that insufficient; they’ll bring disastrous economic side effects. The austerity measures already imposed on Greece by its lenders have severely hurt the Greek economy, which shrank by 2.1% in 2009 and 4.5% in 2010, and which will probably contract by a further 3.5% this year. Greece’s bondholders are effectively stepping on the country’s neck, making the prospect of full debt repayment all the less likely. Delaying a debt restructuring by even one to two years would mean that the amount to be recovered by bondholders could shrink from 50% to 30%, according to Citigroup. Delay a few more years, and the amount recovered could be next to nothing. Meanwhile, Greece’s economy would keep shrinking. That would bring dire human costs, says David Goldman, formerly Bank of America’s head of fixed-income research. Unemployment could approach Spain’s levels: 20% overall, with youth unemployment near 40%. Emigration would rise, Goldman says. Some public services could be halted, and protests could grow deadly again. Another bailout won’t help. « Greece is bankrupt, » says Mark Grant, head of structured finance and corporate syndication at Southwest Securities. « To give Greece more money makes no sense. It just means they get more money they can’t pay back. »
Barron’s Foreign Editor Vito Racanelli offers solutions to help solve Greece’s debt crisis. Suggests Greece be allowed to delay its debt and reduce payments to bond holders. The better course is to allow Greece to write down its debt now and try to get its economy growing again. Not that a write-down would be painless. With Greece’s public debt at €327 billion, a 50% write-down means roughly a €160 billion loss for creditors. Many of them are Greeks themselves, of course. Greek banks would need complete recapitalization, and the rest of the financial system would need huge injections of cash. The European Central Bank, which is adamantly against a restructuring of any kind, holds an estimated €40 billion to €50 billion of Greek debt, and more in loans — so the ECB would need more capital to absorb the blow. The money would have to come from wealthier EU members like Germany and France. Such countries have a huge stake in avoiding a European recession, and in keeping the euro intact. Since the common currency was adopted in 1999, companies in industrially advanced countries like Germany and France have found it far easier to export to European countries that are less competitive, including Greece, Spain, Ireland, Portugal and Italy—the very countries that now find themselves with serious debt problems.
LETTING THE EURO UNRAVEL would be an economic tragedy for Germany and France as well as for Greece, Ireland and Portugal. Short-term, a Greek restructuring could send the euro down sharply. The market is already anticipating a restructuring of some kind. Depending on their maturity dates, Greek bonds are trading at just 45 cents to 75 cents on the euro. A 50% write-down of Greek debt would cause losses of tens of billions of dollars at Europe’s commercial banks. But most of them could absorb the blow. If a few couldn’t, they could either look for new capital, or merge with stronger banks.
It’s likely that a Greek restructuring would increase speculation that similar moves would soon follow in other debt-laden European countries, such as Ireland and Portugal. And such write-downs could well happen. But those countries may not need such drastic action, and, even if they do, the write-downs required may not all be as much as 50%. One estimate showed that a 32% write-down of the debt of Greece, Ireland and Portugal would cost Europe’s commercial banks €200 billion. That would eliminate a year of the industry’s profits before provisions for loan losses, according to Credit Suisse. By allowing Greece to keep limping along when it needs major surgery, European officials have propped up Continental banks that would have failed. That may seem laudable to some, and it may preserve bank jobs in the short run, but it has caused lingering uncertainty, and hurt long-term economic growth.
Contrast Europe with the U.S., where in the most recent financial crisis, the government allowed a surprising number of major financial players to fail or be bought in fire sales. Among them: Lehman Brothers, Bear Stearns, Washington Mutual, Wachovia and Countrywide Financial. Result: The U.S. now has a stronger banking system — and a stronger economy than Europe’s. It can be argued that the EU would also help its economies by allowing weaker financial players to be winnowed. In understanding a country’s financial health, analysts usually compare its government-debt level with its annual economic output. Economists generally believe that once debt rises above 90% of gross domestic product, a country’s resources go mainly to (unproductive) interest payments. What lies ahead could be economic disaster in the form of a constantly shrinking economy and a constantly rising jobless rate.
Greek debt stood at 143% of its annual economic output at the end of last year. But as the nation’s economy shrinks, the ratio only gets worse, creating a painful downward spiral. The country has no room for error. If Greece’s economy contracts as expected this year, its debt will rise to 160% of GDP next year. Even if Greece executes the bailout plan perfectly, slower-than-projected growth or higher interest rates could push the ratio towards 180% in a few years, say Citigroup and the IMF. To cope with its crisis, Greece has had to cut spending sharply and raise taxes. Its value-added tax, the main sales tax, is headed for an average 20% increase. As a result of such moves, the budget deficit as a share of GDP dropped to 10.5% last year, from 15% in 2009.
Greece is also looking at €50 billion of privatizations, such as the Hellenic Post Bank and the Hellenic Telecommunications Organization. If it follows through quickly, that would be a big help, but that’s a big if. Short of a restructuring, the only other solution would be a Eurobond, where Greek paper would effectively be swapped for bonds backed by the entire euro zone, akin to the way Brady bonds helped ease the Latin American banking crisis in the U.S. two decades ago. Yet the Germans and other countries, despite their talk of solidarity with Greece, won’t back Eurobonds. The political will isn’t there.
A wise lender would have to conclude that the Greeks have given just about all they can. The only choice left is restructuring — and if that doesn’t happen soon, a vast array of bondholders will be wiped out. Sovereign defaults have been dealt with time and again. Bondholders know they’re going to take a loss. But by taking steps to relieve some of the debtor’s obligations, they can avoid total loss.
That’s the kind of help that Greece needs — right now.