The Corner

Doing the Math

Here’s a grim piece by the FT’s Gillian Tett on the choices facing Europe. A key extract below:

Slightly more than two weeks ago, eurozone leaders and the International Monetary Fund unveiled a €750bn ($920bn) package that, in effect, guarantees that Greece will be funded for the next couple of years. That pot is also big enough to cover Portugal and Spain, if those countries needed aid.


So far, so good. But what is crucially unclear is what happens after that point. Right now, of course, Greece is implementing a sweeping austerity plan. But the underlying maths of its fiscal problems – with its public debt to GDP forecast to hit 150 per cent – makes it extremely hard to believe that Greece will really fix its woes before the aid runs out.

Now, it is possible that markets will have calmed down by that point; or maybe the aid package will be rolled over, indefinitely. But bond investors feel nervous about assuming that, given the mounting political pressures on both sides of the Atlantic.

So the worry for Greek bondholders today is that they are now becoming subordinate to the IMF and the eurozone, but without any guarantee that this bail-out will work. Hence the concern that this game will eventually result in a restructuring.

If so, just how big might any haircuts be? History points to a wide range of possibilities: as the IMF notes, in some recent restructurings (such as Ukraine) some investors got less than 20 cents in the dollar; in others (Russia and Argentina) they got more than 60 cents.

But if you imagine, for the sake of argument, a gloomy scenario where Greece produced a 50 per cent haircut, there would be nasty implications for European banks that hold a big chunk of those bonds. Bank for International Settlement data suggest that German banks’ exposure to Greece is about $50bn, while the French exposure is $75bn, and both countries banks also have exposure of more than $250bn to Spain and Portugal.

As Ms. Tett goes on to say, none of the policy alternatives look attractive. If I had to guess, a Greek ”restructuring” now looks inevitable. The trick will be to pull it off without triggering an even wider panic.

Right on cue:

SAN FRANCISCO (MarketWatch) — Fitch Ratings on Friday downgraded Spain’s long-term foreign and local currency issuer default ratings to AA+ from AAA. “The downgrade reflects Fitch’s assessment that the process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term,” said Brian Coulton, the head of EMEA sovereign ratings, in a statement. “Despite government debt and associated interest costs remaining within the AAA range, Fitch anticipates that the economic adjustment process will be more difficult and prolonged than for other economies with AAA rated sovereign governments, which is why the agency has downgraded Spain’s rating to AA+.”


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