Why the ECB won't allow restructuring

With every passing day, the whispered rumours that began last winter have grown louder and more menacing. But regardless of the term used — whether it be reprofiling, rescheduling, or extension of maturity — the European Central Bank (ECB) has refused to listen to any talk of a restructuring of Greece’s sovereign debt, which would involve a financial contribution from private creditors.

Hitherto in complete agreement, the ECB and Germany are now publicly at odds over the issue, with Berlin arguing that restructuring is necessary, and that private creditors should also carry their share of the burden. And Germany is not alone. Berlin has also rallied support from the Netherlands, Finland and even, to a certain extent, from Luxembourg’s Eurogroup President Jean-Claude Juncker. France is ranged against them, maintaining unqualified support for the ECB's position.

European leaders and the ECB continue to deny the reality, believing that despite the failure of the first bail-out, a second drastic austerity package accompanied by massive privatisation of state assets will suffice to keep Greece afloat. However, the figures do not leave much room for hope. With its buget deficit soaring, Greek public debt is set to exceed 150% of GDP by the end of the year.

According to economists’ calculations, the country will have to achieve a primary budget surplus of at least 6% over the next ten years if it is to be able to honour this mass of debt. However, taking into account the weakness of its industry and economy, Greece currently has a structural deficit of 5%. And austerity packages will only make it harder to balance its books. You have to accept the reality: Greece is insolvent.

'Better a sinner who returns to solvency'

Why has the European Central Bank refused to acknowledge this fact, and why has it ruled out any restructuring of Greece’s debt? At worst, it only amounts to 300 billion euros, certainly a hefty sum, but one which barely represents 2 per cent of Europe’s GDP.

If its debt is restructured, Greece will be banned from the markets for years, and it will be impossible to refinance the country - so say the bankers at the ECB. But the fact is that Athens has already been totally excluded from financial markets.

“States which have restructured their debts have not found themselves in an impossible position. Far from being banished by the markets, they are generally able to quickly regain their confidence: investors prefer a sinner who has returned to solvency than a debilitated paragon of virtue. Twenty years ago, when Poland negotiated a reduction of its debt, it did better than Hungary, which set more store on its reputation. Debt reduction does not lead to a permanent bad reputation,” points out Jean Pisani-Ferry of the Bruegel Institute.

Mario Draghi, who today was confirmed as the future head of the ECB, has also spoken of the risk that restructuring will trigger a credit event that will be viewed as a default. But the much dreaded credit event has already happened. On 13 June, the ratings agency Standard & Poor's cut Greece’s credit rating to CCC, making it the lowest rated country in the world. In short, the ratings agencies are already anticipating that Greece will default.

Shortly afterwards, Moody’s placed BNP Parisbas, Société Générale and Crédit Agricole on review for a possible downgrade in view of their exposure to the risk of Greek default.

European banking is still inscrutable

The three French banks have been reassuring about their investment in Greece. But their statements do not square with statistics published by the Bank of International Settlements, which speak of 10.5 billion euros of French bank exposure to Greek government debt.

The lack of transparency on the figures for bank exposure is universal, and it is also the case for the ECB. According to some sources, the European Central Bank’s exposure to Greece is 45 billion euros. However, the Wall Street Journal speaks of 120 billion euros of exposure. Who should we believe? The situation reflects a worrying reality: in spite of the crisis and all the promises for more regulation and supervision, the European banking system remains an unopened “black box.”

Citing the pretext of the crisis, the banks have been able to ride roughshod over the rules of accounting and to keep their books as they wish. The stress tests that were conducted last year to guage the solidity of more than 90 of the largest European banks were a caricatural illustration of a lack of transparency. Three weeks after they passed all the tests with flying colours, three Irish banks went bankrupt!

This situation is a consequence of the choices made by the ECB and European governments in response to the crisis. Instead of obliging the banks to disclose their books and to remove all toxic assets from their accounts, instead of forcing them to recapitalise, the leaders preferred to play for time.

For its part, the ECB lent them as much money as they wanted at a rate of 1%. By lending it on at rates of 3%, 5% or even 8%, it was easy for the banks to make fresh profits. As early as last year, most of them were able to post miraculous results, which made everyone believe that there had been a full recovery from the effects of the crisis. But this is an illusion, because the banking system has not been reformed.

The first bailout was a plan to rescue the banks

The same strategy of payments and decisions was adopted in response to the explosive emergence of the Greek and sovereign debt crises in Europe. The first Greek bailout was first and foremost a plan to rescue the banks, so that they could overcome this obstacle and discreetly get rid of cumbersome bonds.

Instead of changing tack, the directors of issuing institutions, supported by some European governments, preferred to stay on the same course. They cited the supreme argument that was supposed to silence any opposition: that a restructuring of Greek debt would trigger a chain of events that would be even worse than those caused by the Lehman Brother's bankruptcy in 2008. According to the ECB, the entire European banking system would collapse.

But regardless of the ECB's wishes, the contagion has already spread across the eurozone. Portuguese and Irish debt is progressively beginning to resemble Greek debt. The banking system remains under threat — and the ECB is well placed to be aware of this. For months, it has been obliged to ensure the liquidity of Portuguese and Irish banks spurned by the interbank market. In recent days, the Spanish banks have also come knocking for funds that they cannot obtain from other banks.

How long will European leaders persist in postponing the clean-up of major banks? Numerous analysts have pointed out that the question now is not whether Greece will restructure, but how and when it will. The change will have to come soon. Otherwise Greece will collapse and take the eurozone down with it.

Translated from the French by Mark McGovern

Economy

When does debt become unsustainable?

“Should we force countries drowning in debt to slash their budgets? First posed in the late 90's at the time of the agreements on cancelling the liabilities of poor countries, this fundamental question now faces European leaders,” writes the Swiss daily Le Temps. “And what is a sustainable debt?” it continues. “The issue was at the heart of the Forum on Debt Management organised in early June in Berne by the World Bank to mark the twentieth anniversary of the debt relief programme for heavily indebted poor countries launched by Switzerland in 1991. It was hard not to think of the Greek situation when Peter Niggli, director of the NGO Alliance Sud, recalled the 'twenty years of economic depression suffered by Africa,' which after the debt crisis of the 1980s was offered 'fresh debts to pay off older ones, even while austerity programmes were being brought in.' Niggli also recalled that ten years ago, in emerging countries, a state debt was considered 'unsustainable' if the interest payments exceeded 15 per cent of export earnings. During the reconstruction of Germany after the Second World War, that ratio was estimated at less than four per cent. A year ago, taking part in the first rescue plan for Greece, the IMF pointed out that in Greece this charge would reach a 'peak of 62 per cent before declining to 17 per cent in 2015.' Since then the Greek economy has continued to decline."