With less than a month to go until Athens faces an amortization of €14.4 billion, the Greek government finally set the date for its “voluntary” debt swap. Bond holders will have three days, between March 8 and March 11, to tender their bonds. Although the prospectus and term sheet are yet to be released, creditors are expected to get a nominal cash sweetener, a coupon of 3.75% (that will step up if the country’s GDP growth rate increases) and new 30-year bonds. At the same time, the Greek parliament is preparing legislation that will retroactively insert Collective Action Clauses that will force minority bondholders to accept the terms and conditions of the exchange. Of course, this applies to the bonds that were issued under Greek law, which constitutes the bulk of the outstanding stock of debt. However, it does not apply to the bonds that were issued in other jurisdictions. It is unclear what will happen to them. Most of the European Union wants to make sure that Greece does not default on its debt in order not to trigger the Credit Default Swaps (CDS). Therefore, there is a chance that the Greek government will continue to service these instruments. However, not all of the European countries are so committed to seeing Athens through the crisis. In addition to Holland and Finland, Germany appears to have thrown in the towel. The German government is divided down the middle, with Chancellor Angela Merkel still pulling for the Greek cause and Finance Minister Wolfgang Schäuble giving up the ghost. Unfortunately, most of the German electorate and a good part of German industry are in the latter camp. The interesting thing is that Schäuble is no Eurosceptic. On the contrary, he is an ardent believer in the currency union, having witnessed the revitalizing effect it had on the German economy. The Eurozone absorbs 60% of German exports and generates 80% of its trade surplus. Nevertheless, he has no confidence in the Greek government and doubts that they will ever live up to their promises. Meanwhile some European governments, such as Ireland and Spain, implement draconian spending cuts and labor reforms to bolster competitiveness, Athens dithers in procedural maneuvering and petty politics. All the while, it continues to drive itself deeper into insolvency. The result is a spinning vortex of financial hell.
The situation is so tenuous that the Eurozone finance ministers recently obtained a legal opinion on what would be the consequences if the debt restructuring was cancelled after it was launched. The answer was that it could be pulled without any repercussion, but that such a move was unadvisable. There is a growing sentiment that Greece should no longer be part of the Eurozone, and that the only solution is expulsion and disorderly default. Clearly, the massive scalping imposed on the private sector is not enough to return the country to solvency. The problem is that it owes too much money to official creditors who are senior to private sector bondholders. With a total debt stock of 160% of GDP, almost half of it is due to official creditors—who will not accept any reduction in principal. This means that most of the burden is shifted onto the private sector. Yet, this is the tip of the iceberg. Stabilizing the country’s debt load at 120% of GDP, which is still an unsustainable level of indebtedness, requires years of draconian fiscal adjustment, an extensive privatization program and painful economic reforms. None of which are possible under the country’s fragmented political framework. However, a disorderly exit from the euro would see Greece plunge into chaos, with capital controls, shortages of goods, bank failures and massive social unrest. It would also lead to a deep devaluation of the currency. Using the variance between the Greek and German deflators over the course of the past decade, the new currency would need to devalue by 20% in real terms in order to regain labor competitiveness. Given the inflationary pass-through that is associated with maxi-devaluations, the currency overshoot would need to reach 40% to 50% to allow the Greek economy to return to equilibrium. This means that the government would have to virtually repudiate all of its debt to the private sector by redenominating its instruments into local currency bonds and applying a huge haircut, as well as forcing official creditors to absorb considerable losses.
Although Europe has prepared for such a scenario, the consequences will be formidable. The triggering of the CDS contracts will maim a handful of German and French financial institutions. It will also bring pressure on the other peripheral countries that are on the ropes, such as Portugal and Italy. Such sobering possibilities may force cooler minds to prevail in order to avert being sucked into the swirling vortex of terror.