Guest Post: The Eurozone Is Almost Out Of Options

Submitted byu Raoul Ruparel – head of economic research for Open Europe

Over the last few weeks, negotiations over a potential write-down of Greece’s debt have taken us here and there, and back again – and at the time of writing, they remain unresolved. But whatever the outcome of the talks between the Greek government and its creditors, let’s not forget the bigger picture – ultimately, the current approach to Greece’s enormous economic problems is failing. Another bailout along with a “voluntary” Greek restructuring cannot be put together in a way that makes it politically acceptable and/or economically viable – it simply will not return Greece to solvency. The insistence on greater austerity, despite EU leaders’ recent talk about growth and jobs, is reaching its political and civil limit in Greece. While Greece clearly needs to consolidate its budget, it cannot live on austerity alone.

Even if a deal can be agreed between the Greek government, its bondholders and the Eurozone, it will most likely fall well short of the debt reduction (or funding stream) needed to give Athens breathing space. As things stand at the moment, the immediate debt reduction under a restructuring would be minimal, leaving Greece’s debt burden hovering worryingly above 140 per cent of GDP. Furthermore, in a best case scenario, Greece would still have a 120 per cent debt to GDP ratio in 2020 and would need to find a scary €252bn (£210.24bn) before then to stay afloat (if it meets all of the targets laid down but the EU/ECB/IMF troika). All of this points to a depressing prediction: even with the haircut currently being discussed, Greece could still be forced to undergo a full default within the next few years. The numbers simply do not add up.

Apart from all the economic complications this would throw up, a full default after two bailouts and a voluntary restructuring would be political dynamite. A massive amount of Greek debt would be held by taxpayer-backed institutions – specifically the ECB, the Eurozone bailout fund (EFSF) and the IMF. Given the seniority of the IMF, most of the losses would fall on the Eurozone. Opposition to taxpayer-funded bailouts is already at fever pitch in the AAA-rated countries – how will voters in these countries respond when their money is actually lost? This is a huge unknown.

This begs the question, should the official sector accept losses this time around, to avoid potentially greater and more painful losses in a Greek default down the road? On one level, this would be the most sensible option – by far. But on another level, it’s a huge ask from the Eurozone and the ECB, since, again, it involves explaining to taxpayers that their money has gone missing.

The ECB, in particular, has got itself into a very difficult position, owing to its legally questionable government bond buying programme, which some Eurozone governments have now become dependent upon. If the ECB was to take losses, it would probably be seen as having directly financed Greece (against its statute). The ECB would instantly see its credibility and reputation as the heir to the Bundesbank demolished. Would the Germans accept this?

But don’t forget, avoiding losses could also have huge consequences. It effectively announces the ECB as senior to private bondholders, sending reverberations into the bond markets given that it owns €220bn of Eurozone sovereign debt. Is there a pragmatic solution then? Possibly.

Losses on EFSF loans would be compensated by smaller future aid to Greece and the reduction in political tensions between Greece and the rest of the Eurozone.

Meanwhile, the ECB could take a partial write-down, which will not have a material impact on its balance sheet. The ECB purchased its Greek bonds at around a 30 per cent discount. It could accept a 30 per cent write down without taking any losses, which would give Greece some additional debt relief (and would provide some good will to investors). Another option would be for the bonds to be bought by the EFSF (at cost price) and then submitted by the EFSF to the voluntary restructuring. The EFSF could absorb the losses without the legal and political fallout. Even so, the ECB would have to admit failure, since it always claimed it would hold the bonds to maturity.

Admittedly, setting a precedent of official sector losses would raise huge questions over whether Portugal and Ireland will request similar treatment. However there are now no easy options. The current course of a second Greek bailout could just as easily have knock-on effects in the form of a second round of taxpayer-backed rescues. We have always argued strongly against taxpayers taking losses but, unfortunately, this is one of the few plausible options we’re now left with.


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