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Friday, April 15, 2011

Wrestling with a Greek restructuring

The talk of a Greek restructuring has resurfaced again, following Wolfgang Schauble’s seeming acceptance that one might be necessary in the near future. It looks like he’s back tracked today, claiming he was ‘misinterpreted’, but the damage was already done - Greek cost of borrowing has already hit new highs and the euro weakened significantly.

As we’ve noted on this blog many times (here and here, for example) and in our Greece paper, a debt restructuring is unavoidable, Greece is essentially insolvent. It’s been trying hard to enact the necessary austerity but the evidence is against the government – tax revenues have barely increased, spending cuts are proving hard to enact and the population is already fed up with austerity in all its forms.

There are a couple of points which have been raised with us recently on the negatives of a Greek debt restructuring: it will take down the Greek banking sector and there is significant moral hazard. Undoubtedly, it is a risky proposal but from what we can see, there are few other options to tackle the long term (and in this case short term) problems.

On the risk to the banking sector, there is no doubt that Greek banks hold huge amounts of Greek sovereign debt but that just serves to underline that they’re unsustainable. All the large Greek banks need to be restructured and recapitalised. Combining this with a sovereign debt restructuring is just good sense. They may need some capital injection and a lot of ECB help, they may even need to be nationalised while all this takes place but in the end the newly streamlined banks will serve the economy far better than the bloated inefficient current ones ever could.

As for the moral hazard, it is a valid concern that it could encourage other nations to seek debt relief but unfortunately we’re now in the realm of lesser evils. With bailouts or fiscal transfers you get a double moral hazard – firstly to the governments, who are not being reprimanded for their profligacy, and secondly to banks, who took huge risks which they could not cover – at least a restructuring shares the burden between the two.

It looks like Greece is coming to the end of the road, a decision needs to be made otherwise a chaotic default could be on the cards before 2013 and nobody wants that. Greece is priced out of the markets for the foreseeable future, the public is fed up with austerity and taxpayers across Europe are tired of paying to support ailing economies; what more is there to lose from a debt restructuring?

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