Greece needs a writedown, not a buyback

The prime minister of Greece took a large political risk Oct. 31 to keep Greece in the euro, just as other euro area leaders appear to be recognizing that the country needs more time and more relief from its debt obligations to survive.

That?s progress. Lowered interest rates for Greece and help with a debt buyback are among the ideas under discussion. Any move by Germany to work with Greece is welcome, even if things are only where they should have been two years ago.

The coming week?s flurry of deal-making may secure the release of Greece?s next 31.5 billion euro ($40.8 billion) aid tranche. Yet a possible debt buyback for Greece would not reverse the country?s downward economic and political spiral. Nor will the further 13.5 billion euros of budget cuts and tax increases that Prime Minister Antonis Samaras accepted publicly yesterday, at the risk of collapsing his coalition government.

Why the pessimism? Because more than 9 billion euros of cuts and other measures will take effect next year, meaning that further recession is pretty much guaranteed. Five years into a contraction that has so far wiped out almost a fifth of the Greek economy, ordinary Greeks and bond markets alike still need to be shown a believable route to solvency and growth.

Losing Buybacks

The new budget that Samaras presented to his parliament on Oct. 31 projects that Greece?s government debt will rise to almost double the size of the economy in 2013, or 189.1 percent of gross domestic product. As we?ve shown before, the kinds of budget surpluses needed to bring that level of debt under control are not historically plausible for Greece.

The debt buyback idea is appealing, not least because it allows Germany to agree to a debt reduction measure for Greece without having to cross its own red lines of forgiving debt that the country owes to the German government or the European Central Bank. Under a buyback, the European Stability Mechanism, the euro area?s permanent bailout fund, probably would loan Greece money to buy its bonds from investors at the current, discounted market rates. Greek 10-year bonds, for example, traded yesterday at about 32 cents on the dollar, so in theory Greece could retire three dollars of loans for every dollar it borrows.

Here?s the problem, though: debt buybacks have perverse effects. As Stanford University economics professor Jeremy Bulow showed in a joint paper with Harvard?s Kenneth Rogoff during the Latin American crisis of the 1980s, buybacks tend to drive up the price of remaining bonds, leaving the market value of a government?s debt little changed. For Greece, Bulow tells us, ?This is a case of proposing to spend money for the purposes of facilitating accounting make-believe.?

In addition, a buyback could only address a part of the roughly 40 percent of Greece?s 340 billion euros of debt that is privately held. According to researchers at Greece?s Eurobank, a 30 billion euro buyback that works efficiently would knock about 12 percentage points off Greece?s debt pile by 2020, leaving it still well above the IMF?s 120 percent of GDP target.

What?s needed now is a writedown of Greek government debt owed to official creditors, as the International Monetary Fund?s Christine Lagarde recently suggested. Official lenders hold about 60 percent of Greek government debt.

Failed Commitments

We see the outlines of a possible deal here, albeit one that would require extraordinary political courage as well as legal changes in Germany, Athens and at the European Central Bank. Germany and other official lenders would need to accept a writedown of their debt, and at the least commit to directly recapitalize Greek banks when that becomes possible, a step that would remove up to 50 billion euros from the government?s liabilities.

The other side of the Greek impasse is the repeated failure of governments in Athens to carry through on the commitments to which they signed up in two previous bailouts.

The top priority here has been to rebuild the dysfunctional Greek tax collection system. Results have been disappointing: Since January, the tax service has been without the independent chief that the government promised to give it. In equally dispiriting news, when a journalist recently published a two year-old list of 2000 Greek groups with bank accounts in Switzerland, the journalist was prosecuted and is now being put on trial.

Small wonder, then, that Germany is worried about giving Greece more help. German Finance Minister Wolfgang Schaeuble has proposed that bailout money and future Greek budget surpluses should go into a trust fund, which would be kept out of the reach of the Greek government. This seems reasonable. Greece should also agree that in areas such as tax collection, failure to act will mean handing over more power to the technicians of the EU?s Task Force for Greece, who already are working with Greek ministries.

These aren?t precedents that we like or want to see repeated, but Greece has shown itself to be a special case. It needs the kind of deep changes that new EU applicant countries must now go through in order to join. If Greek and euro area leaders don?t want to take the risk of a currency meltdown that a Greek default might entail, then they need to be bolder still.


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