Will German Push for Greece Restructuring Tank the Greek Banking System?

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.

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  1. financial matters


    Chinese inflation and European defaults

    Nov 24th, 2010 by Michael Pettis

    Part 1. Will Europe face defaults?

    I think it is pretty safe to make the following predictions:

    1. Greece will be forced to default and restructure its debt, and the restructuring will come with a significant amount of debt forgiveness. The idea that it can grow its way out of the current debt burden is a fantasy. Remember that when countries are in conditions of financial distress, they face systematic disinvestment and capital flight, and as a consequence are never able to grow at anywhere close to the necessary rates – especially since any growth they do manage to achieve generally comes from additional fiscal spending, which simply runs up debt further.

    2. Greece will not be the only defaulter. Spain, Portugal, Ireland, Italy, Belgium and much of Eastern Europe will also face severe financial distress and possible default. History suggests that when a country is experiencing a solvency crisis, growth comes only after debt forgiveness, and many or most of those countries will also be forced into debt forgiveness.

    3. Political radicalism in these countries will rise inexorably as a consequence of rising class conflict. As Keynes pointed out as far back as 1922, the process of adjusting the currency and debt will primarily be one of assigning the costs to different economic groups, and this is never an easy or conflict-free exercise.

    4. So why not bite the bullet and just get it over with? Because the European banking system would not survive even the best-case restructuring scenario. As a consequence we are fated to witness several years of difficult economic adjustment while everyone pretends that these countries, under the right policies, can work their way through their debt burdens. What will really be happening is that European banks will aggressively rebuild their capital bases, with the unwilling help of the poor household sector, until they are sufficiently well capitalized to begin taking the write-offs. Only then will we recognize that some countries cannot repay their debts.

    5. As an aside the European junk-bond market might take off.

    6. Several countries, most notably Spain, will be forced to choose between giving up sovereignty to Germany, suffering extremely high rates of unemployment for several years, or giving up the euro. They will almost certainly choose the third option. There are still a lot of people who say giving up the euro is “unimaginable”, but that just shows a weak imagination.

    1. Paul Tioxon

      The conflict between the nation-state system with sovereignty defined by international law, more or less, is in direct conflict with world-wide capitalist system, and its various property rights, such as they are. There is no other world wide system in the waiting or inevitably coming into to its own unique form according to some non existent laws of history. While the political decision making system can be captured or dominated for the most part, by adherents to the capitalist system, the nation state is by its nature sovereign, and not just the geopolitical demarcation we all have been socialized to understand to be a country.

      Spain can not give up its sovereignty, it will not be the nation Spain, it will become something else, more like Pennsylvania is in relation to the US Federal Government. No one thinks of Pennsylvania as a sovereign state, in control of its economy. Similarly, Spain or any other member will not give up sovereignty or even a bit of it to another country, but to the “Euro sub system” of the world wide capitalist system. Maybe the Communist Party of China will never give up the national sovereignty of China, but the European nations will have to come to grips with what they are and what they are not. They are not subsidiaries of banks, and they are not vassal states of a more economically powerful state. Germany is only temporarily prosperous vis a vis other Europeans. They seem to be working out the details of the European Union and the Eurozone, such as it is now, amidst a much larger non governmental system, worldwide capitalism.

      Because the nation state system is composed of elements that are geopolitical entities that do not operate outside of their national boundaries, and do not act, yet, in unison, the uniform commercial global capitalist system is at a “sovereign” advantage. While banks can threaten to pick up and leave NYC for London or threaten to leave London for Singapore or Hong Kong, Spain or any other nation can not threaten to join the USA or the United Federation of Planets for relief from its creditors. Until the “national sovereignty” is given up to form a more perfect and larger union that can contend with the global capitalist system, then nations will always have political disruptions in addition to economic disruptions, simultaneous and inherent in being a political state with some necessary but insufficient economic power to resolve these economic crisis efficiently.

      1. financial matters

        Yes, the Rodrik trilemma except served with a heavy overlay of fraud. I think the fraud needs to be dealt with first..


        Greek Lessons for the World Economy

        Dani Rodrik


        Deep down, the crisis is yet another manifestation of what I call “the political trilemma of the world economy”: economic globalization, political democracy, and the nation-state are mutually irreconcilable. We can have at most two at one time. Democracy is compatible with national sovereignty only if we restrict globalization. If we push for globalization while retaining the nation-state, we must jettison democracy. And if we want democracy along with globalization, we must shove the nation-state aside and strive for greater international governance.

        The third path identified by the trilemma is to do away with national sovereignty altogether. In this case, economic integration can be married with democracy through political union among states. The loss in national sovereignty is then compensated by the “internationalization” of democratic politics. Think of this as a global version of federalism.

        The EU’s difficulties stem from the fact that the global financial crisis caught Europe midway through a similar process. European leaders always understood that economic union needs to have a political leg to stand on.

        When push comes to shove, domestic politics trumps foreign creditors.

        The crisis has revealed how demanding globalization’s political prerequisites are. It shows how much European institutions must still evolve to underpin a healthy single market. The choice that the EU faces is the same in other parts of the world: either integrate politically, or ease up on economic unification.

        Before the crisis, Europe looked like the most likely candidate to make a successful transition to the first equilibrium – greater political unification. Now its economic project lies in tatters while the leadership needed to rekindle political integration is nowhere to be seen.

        The best that can be said is that Europe will no longer be able to delay making the choice that the Greek affair has laid bare. If you are an optimist, you might even conclude that Europe will therefore ultimately emerge stronger.

    2. Ming

      If a country chooses the third route, the country must be ready to contend with either a massive loss of buying power of it’s new currency or an outright refusal to convert it’s new currency. This situation is only dangerous if the country is reliant on foreign imports of system critcal resources that are rapidly consummed ( and hence the nation has no time to cultivate an alternative resource or to adapt to cuttng back the consumption of that resource) such as food or oil..

      Private sector debts in euros, payable to foreigners will have to be renogotated or defaulted on. Of course, this will spread a contagion of uncertanty throughout the financial sector, resulting in a massive euro credit crunch, unless the ECB decides to act like the Fed and offer ‘temporary facilities’ to the various financial institututions.

      Private debt payable to within-nation debtors can be re- structures via mandate of the national government.

      Does anyone have other thoughts / any disagreements on this?

  2. sean

    ”….Yields on German 10 year bonds blew out by 55 basis points to just shy of 14%…”

    Yves ,I presume you mean Greek and not German bonds otherwise game is already over.

    I think your conclusions are very accurate.Here in Ireland the mood of ordinary folk has darkened toward the EU.There is no doubt an increasing nationalism in each EU country along with increasing hostility toward fellow EU states.

    In many countries this is manifesting itself as a battle between the established political elites and their ‘subject’ citizens.Those who who get out in front such as euro skeptic Finnish party,’True Finns’, set to make gains in tomorrows election will increasingly set the agenda as the established elite play catch up with their ‘subjects’.

  3. Viator

    True Finns as well as it’s equivalent on other EU countries like the French Front National or The Dutch Party for Freedom are parties of the right. They are growing fast. That seems to be the trend since not only is Europe plagued by technocratic corporatist centralism but it is also choking on political correctness, scientific Lysenkoism and creeping Islamization all of which are fueling the right.

    1. Foppe

      “not only is Europe plagued by technocratic corporatist centralism (1) but it is also choking on political correctness, (2) scientific Lysenkoism (3) and creeping Islamization (4)”
      1: This is what is normally called ‘Neoliberalism’, albeit with a more social bottom line, so far. Having said that, this claim is way too broad to be meaningful.
      2: I’m sorry, how is this related to the economic crisis exactly? “Third way” or neoliberal parties are in power in most west-european nations, and as such, Europe (including Sweden) has been economically “(neo)liberal” or ‘right-wing’ for quite some time now. And a party like that of mr. Wilders differs from those neoliberals in that its tenets (at least) are fairly socially/socioeconomically conservative. This has very little to do with the “problems caused by” political correctness, however.
      3. Could you be any more vague? Make definite claims or say nothing, but please don’t be as vague as you can in the hope that someone will be confused into thinking you’re saying something insightful.
      4. Oh good Lord, where did you get that idea? Europe is “islamizing” (whatever that means? Do you mean that public discourse is dominated by ‘islamic’ points of view?) at about the same rate as native americans are. i.e., hardly if at all. The only thing that has been increasing over the past few years is the media frenzy over “islamization”.

  4. Allen C

    No surprise that Greece and their banking system is essentially insolvent. The Extend and Pretend phase has to end sometime. This means defaults, haircuts, and repricing of risk. Sorry kids. Some boo boos are not so easy to fix.

  5. foosion

    The last numbers I saws showed foreign banks, including German banks, held a whole lot of Greek debt. Have German and other Eurozone banks managed to shed their Greek holdings?

    The smart move for Greece might be to both get off the Euro and to default. If Greek banks get hurt, save them.

  6. Foppe

    The worst thing about the Greek case is that the IMF/EU are going to push for mass privatization regardless of whether there is debt restructuring, so that we can be assured that living standards will be dropping further in the near future, while whoever buys up those assets will get even richer…

  7. Hubert

    Memo to Schäuble: Do not talk about it, DO IT. YESTERDAY. Actually, LAST YEAR.
    The Greek banking system is melting into Europe anyway piece by piece. Does anybody think any Greek with half a brain will hold his Euros in 2013 in a Greek account with a Greek bank?

  8. bluffraise

    The ECB needs to hire a few in house shrinks. One of the hardest things in life is to be honest with yourself. Supersized ego = Just don’t get it.

    1. Valissa

      Hopping into this ridiculously petty argument to say I quite liked the use of “tank” as a verb… nice poetic touch, evocative of the situation at hand.

      1. R Foreman

        I kind of like ‘anchor svelten about the neck and lobbed portside into the drink’.. more and more countries can be described this way, and it just evokes such imagery.

  9. Chris Rogers

    Whilst Germany may be the largest donor to those states that are currently suffering sovereign debt issues, I think its necessary to point out that not all European Union members embraced monetary union and the Euro – certainly not the United Kingdom, Sweden or Denmark.

    Its also worth remembering that the ECB is housed in Frankfurt, so hardly surprising the German’s are taking a leading role in stabalising the system.

    Its not worth going into the merits or demerits of the Euro or lack of cash-transfer system from rich regions to the poorer ones.

    What’s interesting is the fact that after what seems an eternity, the question of debt restructuring is now being taken seriously – and about time too.

    To put it bluntly, since the financial crisis hit in 2007/8 and Euro debt crisis emerged in 2009, governments the world over have seemed hellbent on preventing bond holders, be they sovereign or commercial, from taking haircuts – obviously, the stress tests undertaken in the USA and Europe had something to do with this little issue.

    Hence, its about time those who made disastrous investment decisions and brought into the pre-2008 hype should be punished – obviously, this will effect capital ratios in many banks, some of which are screaming blue murder at being forced to adopt that half-baked measure known as Basel III – Deutsche Bank where are you!!!!!!!

    The downside unfortunately for us, the actual consumer or pension fund holder is it will be us, and not those that caused the crisis, that will shoulder much of the burden in lower pension payouts and higher bank charges as they again restore capital destroyed by investing in the PIIGS – I’ll add Belgium to this as well.

    Still, the investment managers and credit rating agencies have all collected their fees and bonuses, whilst it is left to us to pick up the pieces.

    Time for a rethink me thinks!!!

  10. Mark

    Lorenzo Bini-Smaghi is a financial terrorist that quotes Osama bin Laden. His take on the plight of the citizens of Ireland: ECB Executive Board member Lorenzo Bini Smaghi yesterday: “Irish people also elected the governments that regulated the banks as the problems built, Mr Smaghi pointed out.
    “If taxpayers have the right to share in decision-making, they must also accept the consequences,” Mr Smaghi said.

    bin Laden in 1997: bin Laden in 1997: “As for what you asked regarding the American people, they are not exonerated from responsibility, because they chose this government and voted for it…”

  11. Philip Pilkington

    “Yields on German 10 year bonds blew out by 55 basis points to just shy of 14% and other credit-stressed sovereign bond yields widened.”

    Supposed to be Greek 10 year bonds — not German.


    German yields fell:


    “The benchmark German 10-year bund yield dropped five basis points to 3.38 percent.”

    Ireland also took a kicking. If the Moodys reclassifying of Ireland to just above junk wasn’t enough…

    “Irish 10-year yields rose 38 basis points to 9.72 percent at 4:42 p.m. in London, the highest since April 6.”

    Wither the Eurozone? If so, tears won’t be shed on this reader’s keyboard…

  12. Than

    Wait, so are you pro-restructuring or anti-restructuring? (Or have you not made up your mind yet?)

    I ask because at the beginning of the post you indicated that you’re pro-restructuruing of Greece bonds, saying that the Germans are taking “an astonishingly sensible position.” But then you say at the end that you’re “overly sensitive to contagion” (after discussing the contagion effects of a Greece restructuring), which would imply that you’re anti-restructuring.

    Am I misreading you?

    1. Yves Smith Post author

      I’m pro restructuring and have been for a long time. But a lot of people seem to be in denial about the fact that the banks are insolvent. And there is no lender of the last resort to the Greek banks in this scenario. It’s one thing for shareholders to get wipe out and bondholders to take losses. They are risk capital and should take a hit. It’s quite another for depositors to take losses. If that happens in Greece, you might see bank runs in other stressed periphery countries.

    2. Ming

      If the pain of debt restructruring must allocated, let individuals who negotiated the debt deals via deception and their enablers ( I. E the Goldman sachs debt pushers) drink the cup of hemlock to the fullest first. The people of Greece should demand a full audit of who did the deal , and post their pictures and the documents they signed, privacy be damned. Then they should conduct a full audit to trace where the Money from the debt went…. If the money ended up as savings for the ordinary people, then the ordinary people must pay it… But f the money mved int the hands of the elites, then the elites shall pay. And if the elites use the financial system transfer the money out of Greece, then this is an act of betrayl of the Greek people (especially if they did not pay the taxes on that income). Arguably an act if sedition or worse… If the money was spent by the ordinary citizen on purchasing foreign goods and services, then I can see the German point f view, the Greeks do need to undergo some suffering for wasting the money….

      A technical question for the community…. how did the various economist estimate the capacity of Greece to pay back the debt? It seems to be a similar problem that Keynes faced when trying to estimate how much war reparations Germany could pay without collapsing.

  13. Observer

    A fed Bear is a dead bear.
    Feeding Greece with grant aids, the West is creating another beast. Greece has created a virtual reality, with a very strong, enormous military, (330 Leopard tanks, F 16 jet fighters, a very powerful Navy, included up to date submarines, and more.)
    The Greek people never learned to pay their taxes …. Because no one is ever punished.
    To make things more interesting Greece has FREE HEALTH CARE, LUCRATIVE PENSIONS, and HIGH PAID JOBS, which they cannot afford either.
    So the WEST is feeding another Bear that soon or later will end in a DEAD BEAR.
    For each ALBANIAN who changes HIS NAME and HIS NATIONALITY from ALBANIAN to GREEK, the Greek Government pays a monthly pension of 400 Euro for life. Most of South East Albanians are getting Greeks pensions. The total is 2 Billion Euros per year and is increasing. Now most of old couples are divorcing, because if they stay together one won’t get the monthly payment.
    There is where Germany Grant GOES …Shame on GREECE, shame on GERMANY.

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