naked capitalism

Funny what a difference a few months makes. Whenever this blog would suggest that Greece, and potentially other eurozone members, might have to restructure their debts, the idea was treated by some readers as a nefarious euroskeptic plot, particularly since badmouthing embattled governments could worsen their conditions by raising their funding costs.

It might now be accurate to upgrade discussion of a Greek default to being an Anglo-Saxon plot. Germany is now at a loggerheads with the ECB, since the German officialdom now appears to think that it’s better to restructure Greek debt now than lend money to it only to have to write it down in the not-too-distant future. That’s an astonishingly sensible position and contrary to the past political reflex to keep trying to kick the can down the road. Not that the German motivations are noble, mind you. Bloomberg tells us:

Chancellor Angela Merkel’s deputies are raising what has been a taboo issue for European officials — a restructuring by a euro member — to show its unwillingness to contribute to more bailouts, Holger Schmieding, chief economist at Joh Berenberg Gossler & Co. in London, said in a phone interview. Germany is the largest contributor to European Union rescue funds, which have been tapped by Ireland, Greece and Portugal.

“This is part of a gambit in negotiations,” Schmieding said. “If Greece doesn’t get access to markets, the funds will probably run out sometime in 2012. That, I think, is the German message: Don’t count on us to add more money.”

So the open question is: are the Germans really serious about a restructuring or is this just an effort (given known ECB opposition to a restructuring) to put the boot on Greece’s neck? The drift of the gist certainly seems sensible:

Greece has “done a tremendous job in reforming the country,” {Werner] Hoyer, who is minister for European affairs, said in an interview in Berlin. “Whether all this is enough, whether the results will be there soon enough, is a different question. We are looking at the economic developments, the fiscal developments in Greece and we are worried.”…

“A haircut or a restructuring of the debt would not be a disaster,” said Hoyer, a member of the Free Democratic Party, a junior partner in Merkel’s coalition. If Greece’s creditors agreed that talks “would be helpful toward a restructuring of the debt, then of course this would be supported by us.”

The problem is that Mr. Market didn’t take at all well to a dose of reality. Yields on Greek 10 year bonds blew out by 55 basis points to just shy of 14% and other credit-stressed sovereign bond yields widened.

The German talk does not appear to be posturing. The Financial Times reports that Germany is sketching out restructuring plans:

One idea is to encourage bondholders to swap risky Greek sovereign bonds at about market prices for safer paper guaranteed by the eurozone – akin to “Brady Bonds” issued to South American countries in the 80s.

Alternatively, a eurozone trust – possibly the European financial stability facility – could buy bonds, and extend maturities or retire debt, a system used to help poor states in the IMF’s HICP programme. People briefed about Berlin’s thinking said other options were considered but chancellery and finance ministry officials had spent time analysing these “market friendly” options.

“The government has long since started preparing for a Greek restructuring,” one of them told the Financial Times. “But it’s not pushing Greece into this. It knows that none of these plans will work if the Greeks don’t want them.”

There is, however, a major fly in the ointment. Per Eurointelligence:

Lorenzo Bini-Smaghi, the most prolific campaigner against default, told il Sole24 ore that the ECB had carried out an analysis on the potential impact of a Greek debt restructuring, and found it would imply the failure of a large part of the Greek banking system, as the Greek banks hold a large portion of the Greek sovereign debt. (Another reason is that Greeks would transfer all their deposit to foreign banks, a process that is already partially under way). At the point the Greek banks would no longer have access to ECB liquidity, and would have to end their support for the corporate sector. He said that since Greece does not have a primary balance, a default at this time would lead to the cessation of pension and other social payments. The Greek economy would collapse, with devastating economic and social consequences. He said the other countries should stop pushing Greece into a catastrophe. In what we would understand to be an indirect reference to Wolfgang Schäuble, he said that talk about restructuring had seriously negative effects on market sentiment.

With markets already worried about the possibility of a Finnish rejection of a Portugal EFSF plan, the spectacle of the eurozone leadership again in disarray at a delicate juncture is pressuring markets. The disconnect between the ever-higher periphery country bond yields and the complacency in the markets ex this sector is puzzling. Perhaps having been unpersuaded at the time by “subprime is contained”, I’m now overly sensitive to contagion, but the Germans digging in their heels is a very serious development, and the bigger implications are yet to be digested.