Is the EuroZone engineering (unintentionally or not) a Greek default in March?

02/15/2012 3:37 pm EST


Jim Jubak

Founder and Editor,

Wikipedia says that Rube Goldberg died in December 1970. But that’s clearly wrong—who else could have designed the latest EuroZone machine for a Greek rescue?

My worry, at this point, is that the machine is so complicated and so ill conceived that it could blow up and force Greece into a March default. Default, I believe is inevitable, but March isn’t enough time to set up an orderly process—especially since many EuroZone leaders seem to think that they’ve got everything under control.

Goldberg’s name has become synonymous with over-complicated machines that go to absurd lengths to accomplish a simple task. For example, there was the “self-operating napkin,” which included a parrot (and crackers), a skyrocket and a sickle in a machine designed to wipe a soup-eater’s mouth. See if the current EuroZone plan for Greece reminds you of that.

Yesterday, when European finance ministers called off their emergency meeting, the ostensible reason was Greece’s failure to specify the sources of a last 325 million euros in budget cuts and the need to have the leaders of the country’s two biggest parties, New Democracy and Pasok, sign pledges to abide by the austerity deal after the country’s April elections.

Well, this morning Athens delivered on both those fronts with a detailed list of sources for the last 325 million euros in cuts and signed pledges from Antonis Samaras (New Democracy) and George Papandreou (Pasok) to honor the deal.

Turns out that’s not enough—because those two items weren’t the real problem at all.

There are two problems, indeed, but they’re a result of internal divisions among the EuroZone countries. While a majority of EuroZone members seems inclined to sign off on the package as negotiated, key members, those that will provide the bulk of the cash, oppose the deal as currently structured.

First, there is a group of EuroZone countries that don’t trust Greece at all. For them, and I’d include Germany, the Netherlands, and Finland (three of the EuroZone’s five remaining AAA-rated countries), even the recent pledges from Samaras and Papandreou aren’t enough. They want to either delay handing over more cash until after a new Greek government to replace the current caretaker government is elected in April, or they want to set up a mechanism that would take the control of how the rescue package is spent out of the hands of any Greek government.

Second, there’s a group—of uncertain membership but clearly led by Germany--of EuroZone countries that believes that the EuroZone has built up its defenses to the point where a Greek default would have only minor consequences for the rest of the currency union. German Finance Minister Wolfgang Schaeuble has been the most vocal proponent of this view. On Monday he said that the EuroZone was “better prepared than two years ago” to deal with a default. That’s almost certainly true since two years ago the EuroZone wasn’t prepared for a default at all. But it is also completely irrelevant since the issue isn’t whether or not the EuroZone is better prepared, but whether or not it is adequately prepared.

Confronted with these divisions, EuroZone leaders seem inclined to do what they usually do—build a complicated structure designed to paper over the differences.

The current Rube Goldberg solution would have the finance ministers at their next meeting on Monday, February 20, sign off on the deal that Greece has struck with bondholders to restructure its debt. But the EuroZone wouldn’t put up any cash at that point. Any decision on actually approving cash to Greece for either the bond restructuring or a rescue package would be postponed until the March 2 European summit or even until after the Greek elections in April.

The theory is, apparently, that going ahead with the bond restructuring deal would give Greece enough room to avoid a default on the 14.5 billion euro payment that it owes on its bonds by March 20.

The assumption behind this machine is that the restructuring, which would cut what Greece has to repay on March 20 in half, would be enough to avoid a March default and give the EuroZone time to strike a deal with a Greek government elected in April.

The Financial Times is reporting today, though, that this assumption has made enough EuroZone officials worried that they’ve asked for a financial opinion from investment banker Lazard on whether approving the restructuring but not providing any money for it could cause the entire bond refinancing deal to fall apart.

And Lazard’s answer—Sure could.

For the bond restructuring to work, someone—the EuroZone countries—has to provide 30 billion euros in cash sweeteners to bondholders to get the institutions that hold Greek debt to participate, and about 23 billion euros to recapitalize Greek banks that would be wiped out when the value of their Greek bond portfolios are cut in half.

Without that money, Lazard said, bondholders would have to decide to participate in the restructuring and to tender their existing bonds for a swap for new Greek debt without knowing if they actually have the deal that they negotiated. Certainly without the upfront cash payment, the swap into new and lower-yielding debt becomes a lot less attractive. Especially when bondholders think about the possibility of any tendered bonds getting stuck in legal limbo for weeks if the EuroZone decides it won’t come up with the cash. (And then there is the issue of what Greek banks, which are already bleeding cash as depositors send money out of Greece, are supposed to do for funds until this gets sorted out in March or even April.)

This uncertainty could keep so many bondholders on the sidelines, Lazard noted, that the swap could fail. That would lead to a Greek default in March.

Right now, I think the key uncertainty is how many EuroZone members buy into the German assurances that a default by Greece would be no big deal because the EuroZone is ready for it.
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