Comments on the Second Greek Bailout

Cross-posted from Credit Writedowns

Edward here. Yves is away so I have a few guest posts up the next few days. Here’s one on Greece.

I will be on CNBC at 1:30ET to talk about Greece. The situation has evolved since I last talked about the sovereign debt crisis on CNBC in May. Greece is now getting a second bailout and the Greek government is attempting to get the austerity measures upon which the bailout is conditioned passed through its legislature. I think largely the same issues still apply though.

Here are the bullet points from the piece I wrote after the last CNBC appearance.

  • Greece needs a strategic plan. At a minimum, a soft restructuring – that is to say, a voluntary reduction of interest rates and an extension of maturities – will happen sooner than later under the EFSF facility. While this is necessary, it will certainly not be enough. Eventually, principal reduction will occur.
  • Bank capital must be protected from immediate losses. Principal reduction has to be done with timing and in a way that considers the stress to Greek and foreign bank balance sheets. The problem with an involuntary default is that it would trigger immediate losses and panic. Europe’s banks are still undercapitalised; so such a default must be avoided at all costs.
  • It is unclear whether the move to principal reduction will be messy. An involuntary default would clearly be messy. I don’t see this scenario as likely, and it certainly won’t happen in 2011. Instead, I anticipate a soft restructuring followed by a certain amount of political dithering, which will create contagion that forces a hard restructuring (aka ‘soft default’) down the line. This will be “somewhat messy”.
  • Neither Marc [Chandler] nor I mentioned a euro zone break-up. My view is still that some combination of monetisation and a voluntary default, hard restructuring package is the most likely scenario for Europe. When I handicapped scenarios after the Irish stress tests in late March, I felt this way. I still do now. This means that when you look at the three options for the euro zone, monetisation, default, or break-up, I see break-up as by far the least likely. Again, a hard restructuring/soft default is much more likely.
  • Credit default swaps triggers can be avoided. My view is that a restructuring that involves maturity extension, interest rate and principal reduction via an exchange of bonds or a roll off of maturing issues does not necessarily have to involve a technical default that triggers credit default swap payments. If a strategic plan is properly conceived via bond exchanges, investors will lose money but actual default can be avoided. Obviously, a reduction of principal is still a loss of money for investors. But, it is key that this loss take place with as little unwanted negative consequences for other euro zone debtors and the banking system.

What’s changed?

The last two bullets are where I have more doubts now than in May. But mostly this is about politics. If the Europeans wanted to, they could end the liquidity crisis immediately by buying back Greek debt and promising to issue eurobonds going forward. Yields would plummet since the ECB has an unlimited supply of liquidity to deal with short-term liquidity issues and Eurobonds would halt any medium–term liquidity issues.

Eurobonds are a political non-starter though. Here’s how I framed the likelihood of an escalating crisis in May 2010 when Greece got the first bailout:

As you know, the ECB has hit the panic button and used the so-called ‘nuclear option’ of buying up sovereign debt on the secondary market. However, after reading a post from John Hussman yesterday, it occurred to me that the nuclear option may not be enough if, as seems to be the case, foreigners start refusing to buy Greek and Portuguese bonds at auction.

Yes, EU banks might consider buying at auction and then dumping the bonds onto the ECB – at what kind of collateral discount, I don’t know. But this seems a risky strategy to get a yield pickup. As problems with the austerity commitments develop, we might witness an unwillingness by funders of Greek debt to purchase rollovers as default becomes a certainty. And we know that PIMCO has gone on a Greek strike and that the Chinese have become alarmed at Euro debt as well. In my view, unless the Europeans look to the structural issues of the Eurozone immediately, this crisis is going to escalate…

So here is what I see happening; despite the denial by Olli Rehn about Eurobonds, this possibility as a measure to deal with future crises is now being discussed in policy making circles in the EU…

The Germans would not accept Euro Bonds or direct purchases of EU member sovereign debt by the ECB. These are complete non-starters politically. And any attempts to move in that direction would mean the end of the Eurozone.

Now that the second bailout is upon us, the politics have deteriorated even more. Eurobonds and ECB liquidity are dreaded by the core and the ECB. And austerity is dreaded by the Greek populace. To my mind, this speaks to restructuring or default as inevitable. When and how this occurs will determine future political paths and therefore largely determine the outcome.

As an investor, this is a situation you want to avoid. When politics determine the outlook for an investment, look elsewhere. Greece, Ireland and Portugal will all be deeply affected. Likely Spain, Italy and Belgium will be dragged into the undertow. If the Europeans can kick the can down the road a bit, punters might want to have a go at debt in Italy, Spain or Belgium to ride the momentum from a deal. But, crisis will come again until we get a resolution via hard restructurings and defaults.

Contingency planning is going on in private right now to plan for that eventuality. The solution proposed by Evans and Allen looks ever more necessary to keep the euro ship from sinking.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Ransome

    The nations of the euro-zone need to deal directly with the credit creator and cross border banking should be restricted. This would ring-fence every nation while retaining the benefits of a common currency. Greek politicians need to be dragged in front of the ECB every quarter until they get the message. Employment is number one, the wealthy need to invest in the nation and pay some taxes. Socialize services should be revenue neutral otherwise give the private sector a chance. Someone mentioned a Marshall Plan.

    1. chris


      And 80 years later the threadbare fallacy of Keynesianism reveals itself as those who grasp to its corpse cannot escapt the old ideas.

      1. Because

        No more than free market totalitarian constructs seeking the destruction of the middle class and a plutocratic tryanny.

        Your a disgrace “chris”.

        1. don

          free market? what planet have you been residing. more like a social state that is destroying the middle class

  2. /L

    An orderly breakup of the Euro by European politicians, the most sensible thing that addresses the real problem, won’t happen until the Euro break on its own. They are in way capable of doing that they are under the spell of defunct economist ideologies. They will show how responsible they are by go to any length to put the Europeans in deep misery to “protect” their beloved Euro and do it in the name of protecting the European people.

    A quote from a article on John Kenneth Galbraith in The Nation:

    The central theme of The Great Crash is the impotence of people with power when in the grip of ideas that leave them no way of confronting reality. They endorse and protect a consensus that conceals what is objectively true. One of the most caustic passages in the book describes the “no-business meetings” held by Hoover in the wake of the crash, which assembled prestigious businessmen at the White House, to great fanfare from the press. No proposals emerged from Hoover’s meetings. No action was taken. No one intended that anything should be accomplished. And yet by gathering men of wealth and undeniable social importance, Hoover intended to give the impression that something of importance was being done while doing nothing at all. They were, Galbraith wrote, a “practical expression of laissez faire.””

    Also Keynes did have a clear view of these kind of problems:

    Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.

    The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.

    1. Because

      Why, my treasonous friend, I wonder why? Is it because of capitalist overabundence of wealth sucking credit from the entire economy while banks predate to make profit?

      1. R Foreman

        Take the blue pill, wake up in your bed and believe whatever you want to believe.

        If you wish to believe the biggest banks have actual capital, then that’s your choice. Wrapping it into some patriotic slogan makes that blue pill go down a little easier too. I’ve never subscribed to the head in the sand economic philosophy though, so you might find yourself swinging out there all alone. Best of luck to you.

  3. Pat

    The Evans and Allen plan (Brady Bonds, with roughly 50% haircuts through replacing short with long bonds) sounds possible, until you look at some of the assumptions, such as this one:
    “In a hypothetical example, if a “Trichet Plan” country with an initial 140 percent debt to GDP ratio can grow by 5 percent per annum (in nominal terms) over a seven years, while, at the same time, reducing its net debt stock by 7 percent every year, the Debt/GDP ratio would decline to 60 percent of GDP.”
    Who thinks the Greek, Irish and Portuguese economies are going to grow at 5% per year? No rational person. The South American countries and Mexico grew their way out of their debt because the price of commodities increased, extraction increased, and Mexico discovered oil. What commodities can Greece, Portugal and Ireland extract? Not much, I imagine, unless there is some sudden and miraculous demand for parched rock and peat-moss.
    Probably the Greeks et al will be unable to pay even the new, reduced payments within a few years.
    And if the Greeks get haircuts for their debt, the Irish and Portuguese must get them too.
    Another problem is that the European banks will get no advantage from tax write-offs in future years, since they are unlikely to have profits in the future, whereas the American banks with South American bonds had profits they could balance the losses with.

    Probably what will happen is the Eurozone will start in with the soft haircuts, and then some sudden event will intervene and throw everything into panic and chaos, at which point the Eurozone will collapse and everyone will revert to native currencies and capital controls. The event could be some bondholders refusing haircuts, or bank runs, or war in the Middle East, who knows.

  4. DownSouth

    Edward Harrison said: “When politics determine the outlook for an investment…”

    When have politics not determined the outlook for an investment?

  5. attempter

    I think the only strategic plan worth anything is for the people to take back their country and drive all the criminals out with a whip.

    They can start by defaulting from the bottom up, going on a total and permanent tax strike, and taking back all the land that’s been stolen.

    Once again we can have the School of Athens, already once so seminal and fruitful for Western history.

    1. carol

      …. perhaps NO tranches of that second bailout will be transfered, as Greek parliament will of course vote in favour of the additional measures as required by troika,
      but the measures might not be implemented.

      “Greece’s deputy prime minister, Theodoros Pangalos, … warned that although he is optimistic about winning the first round of the austerity vote, he is more wary about securing approval for specific laws to enact fiscal reforms and privatise public companies.

      “That’s where we may have problems. I don’t know whether some of our members of parliament will vote against it. It’s possible,” he said. ”

  6. Jeff

    Anyone who wrote CDS protection on Greek bonds should have their bones picked clean – it’s a joke that sovereign CDS even exist.

    1. F. Beard

      it’s a joke that sovereign CDS even exist. Jeff

      It’s a sick joke that sovereign debt exists.

    2. sayer

      Harrison seems to think it important to avoid triggering CDS’s. Are they the elephant in the room? Did some foolish bank sell a whackload of them on European debt? Is there another AIG out there?

  7. Ming

    Based on the article from der spiegel from yesterday, it is easy to see why the ‘core’ countries reject an ECB bailout and Euro bonds; the financial elites continue to emphasize (via the media ) that core (German) tax payers will have to make up the losses on the Greek bonds. What nonesense! The ECB has the power to print any amount of money necessary to protect core (German) depositors from losses, and can print any amount of money necessary to recapitalize any bank. But it serves the purpose of the elites to sow anger and distrust between the ‘core’ and ‘peripherey nations’; it allows the elites to asset strip the ‘peripherey via ‘asset sales’ , and to create the atmosphere or anger and mistrust that will be required to foment a war between the nations.

    1. VM

      “The ECB has the power to print any amount of money necessary to protect core (German) depositors from losses, and can print any amount of money necessary to recapitalize any bank.”

      Ming – by doing so the purchasing power of the core will still get shot – i.e. it is not protection to print to infinity. Protection has to be real not just notional.

  8. Francois T

    The problem with an involuntary default is that it would trigger immediate losses and panic. Europe’s banks are still undercapitalised; so such a default must be avoided at all costs.

    Then, politicians should stop wanking around the ECB and financial institutions and get serious about the absolute necessity of an orderly default.

    Every week that goes by increases the probabilities that an involuntary default occurs. All you need is, for example, a huge manifestation in Athens that suddenly turn violent, oops! things spin out of control, hundreds of severely wounded plus dozens of dead people and you got the Mother of All Crises in Souvlaki County! Next thing you know, revulsion is extreme, the government must reject austerity otherwise we’re talking guaranteed political hara-kiri, Europeans creditors crap in their pants and all hell break loose.

    And let’s not talk about those US money market funds with Greek debt on their books, shall we?

    This could end very badly indeed.

  9. Psychoanalystus

    Thank you for the bailout, my western European friends. I am sure that when you’ll stop bribing Greece, we’ll kick you asses out, and sink your Euro project just for kicks.

    Meanwhile, I am here in southern California celebrating our Greek anti neo-liberal revolution with a bottle of Hellenic Mythos lager, a cup of fasolada, and a platter of authentic Greek feta and domadakias, to be followed by a sizable piece of authentic baklava.

    I hope my western European friends don’t mind too much, but earlier today I canceled my order for a new German-made Volkswagen. While at it I also canceled my planned trip on Air France, and rebooked on the Polish airline. Sorry, but from now on I will only spent my hard-earned dollars at non western European businesses. But Eastern European products are more than welcome in my household, which is why we often also purchase Bulgarian feta, and in Greece we have a Romanian-made Dacia automobile (higher quality and much cheaper than the auto trash that Germany puts out).

    Once again, my western European friends, I expect you to keep the bailouts coming, else we’ll sink your stupid European empire project before you know what hit you. Got that?! Thank you very much!

  10. Philip Pilkington

    Largely agree, but…

    “This means that when you look at the three options for the euro zone, monetisation, default, or break-up, I see break-up as by far the least likely.”

    Short-term, maybe. But long-term it seems that a breakup is inevitable, no?

    This crisis was a test of the mettle of the Eurozone’s institutions. To say they came up short is a vast understatement. We might say that the US’s institutions came up short. But the Eurozone’s were completely and utterly dysfunctional.

    Even if the Eurozone survives the present debt crisis; it might, it might not. It is now clear that the system doesn’t work. Either the economies will start growing again (doubtful) and another crisis will arise with a decade and a half, or the whole thing will just stagnate (more likely) with unemployment so punishing and output so crappy that some alternative program will gradually emerge.

  11. gf

    yum yum the vile stench of disaster capitalism in the morning.

    Or is that really just the DNA of capitalism .

    I think the latter.

  12. steelhead23

    Perhaps someone else has already broached this subject. You argue that CDS written on Greek debt wouldn’t need to be triggered if haircuts were arranged as extensions or an exchange for lower-yielding Eurobonds. If you were the president of a bank that wrote such CDS, would you be as sanguine? I encourage you to look at Whalen’s take on the CDS issue. The World held hostage by Credit Default Swaps.
    It is basically Whelan’s argument that the spectre of a CDS tsunami is forcing world leaders to attempt to impose Versailles-like solutions on the Greeks. My point is, this is a discussion that must take place with the Bank of International Settlements – the decision authority. If the BIS would issue a finding that replacing Greek bonds with lower-yielding Eurobonds would not invoke any CDS, I suspect the ECB would issue such debt the very next day – and Greece might accept a reasonable plan to pay it off. Otherwise, Greece will explode and the globe’s financial system along with it.

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