What's really going on with Greek debt?

I have been thinking a lot about the Greek debt problem. About a year ago, I looked at the numbers and decided that on economic logic alone, this one will end in a restructuring — the primary deficit was just too big, and the debt too high. Now that the markets and politicians are debating with ever greater intensity if “reprofiling” or a “soft restructuring” will take place, I am beginning to think that we might actually see this one settled without a default. What’s changed? Apart from my contrarian instincts, I think it’s important to remember that there are many moving parts here — the European governments, financial markets, the Greek government, the ECB, and the electorates of Greece and the EU member states stomping up the cash. It’s all a bit like a Ruby Goldberg machine, really. The spread on Greek debt has been soaring of late, and the EU needs to decide on some course of action now that the IMF and EU missions are checking that Athens is doing its share. I get the sense that some operators in financial markets are, in a way, lobbying for a default event – anything that allows people to cash in on their CDS.

I think they may be disappointed. I may be wrong, but the rhetoric coming out of Berlin (and recently, Paris) about reprofiling seems more designed to put pressure on Athens than a good predictor of events to come. I am not saying that a restructuring couldn’t happen, but given that the ECB is vociferously opposed, and that no EU politician wants to be responsible for the next Lehman disaster (as predicted by the ECB if Greece defaults), I think the current discussion is more designed to get the Greek government going – or, more precisely, to give the Greek government an excuse to tell its electorate that there is nothing that can be done to avoid lots more austerity.

My money is on the following: 1. Tough budget cuts and markedly tougher privatization requirements for Athens, maybe in the form of a semi-autonomous agency a la the German Treuhand that handled sales of the East German assets 2. Fresh loans by the Europeans 3. A “voluntary” roll-over agreement with the banks so that they agree to take fresh Greek bonds as the old ones expire. Some of this will be painful in the short term for Greece and for the banks, but it will save the Greek financial system and keep access to outside funding open. As I have said before, making the tax system less distortionary is good for growth. Also, if the confidence trick works, Greek savers may start putting some money back in their own banks, which will help with recovery… and once hedge funds and private individuals in the markets see that Greek bonds offer 25% and are effectively guaranteed by the EU, yields will come down. That was the hope a year ago, and it didn’t work. But that doesn’t mean it cannot pan out this time…

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