Restructuring: By design or by default?

We could be entering end-game territory in the coming months. News from the bond markets about Greece resembles bulletins about Alpine peaks rather than sovereign debt priced within reasonable parameters.

Greek three-year bond yields jumped to over 22 percent this week. Such surreal yield levels are pricing in the restructuring option to take place in the second half of 2011 after the Portuguese bailout has been sorted out.

Credit default swaps (CDS) are price indicators highlighting the probability of a default. This financial instrument — not necessarily the most reliable vector but nonetheless indicative of pricing mechanisms — assumes that the possibility of Greece defaulting in the next five years has increased from 55 percent a month ago to 67 percent in mid-April.

??¨Such yield levels are also a reflection of bond markets explicitly challenging the Greek government and its announcement that it will try to return to international capital markets next year for sovereign debt financing. In the view of bond traders and speculators, this intention is either science fiction or fiscal suicide. In both cases it is self-defeating for Greece.

Bear in mind that the yield on Greece’s 10-year sovereign bond is 14.8 percent today, almost 600 basis points higher than a year ago when, from the remote island of Kastelorizo, Prime Minister George Papandreou requested international financial assistance for Greece.

??¨Once the Lisbon challenge is out of the way, and it is by no means guaranteed that this will be done in a timely manner, Greece?s mid-June evaluation by a team of officials from the European Commission, the European Central Bank and the International Monetary Fund will most likely deliver a rather somber assessment of the current economic and fiscal situation in Athens. And the outlook for 2012 does not look promising either.

Finally, apart from the IMF, which is the notable exception in this cacophony of voices, all other parties involved in the current restructuring debate (the European Commission in Brussels, ECB in Frankfurt, eurozone finance ministers across the continent, Chancellor Angela Merkel in Berlin and government representatives in Athens) are conducting fiscal and economic policymaking through megaphones. That is a recipe for failure.

Consequently, fears are increasing across the European investor community that the eurozone?s financial sector will sooner rather than later have to suffer the collateral damage of such a cacophony. The danger here is that sovereign debt restructuring in one (Greece) or a combination of countries (including Ireland and/or Portugal) is rapidly moving from an unlikely event to an unavoidable one.

The complexity of the subject matter and the political delicacy involved requires that policymakers and decision takers talk behind closed doors. Instead, in capitals across Europe, we are witnessing a tragedy in the making. What should be achieved by design risks becoming the default option.

My hunch is that just as we debated ?bailout? a year ago, we are now moving into ?restructuring? territory. If you take any article about Greece from the past year and replace the word ?bailout? with ?restructuring? you?ll have a revealing sense of deja vu when reading the updated piece. But a year from now not even that will have been enough. Then the new order of the day will be the dreaded D word, i.e. default.

*Jens Bastian is visiting fellow for the political economy of Southeast Europe at St Antony?s College in Oxford, England.

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