Greece Haircut for Bondholders Already Overdue: Matthew Lynn

By Matthew Lynn - Apr 26, 2011 2:00 AM GMT+0300

Bloomberg Opinion

Matthew Lynn

No cakes, party games or music. As Greece last weekend marked the passing of the first year since it was forced to seek a bailout from its fellow euro members, the mood could hardly have been more somber.
Bond yields soared to fresh highs. The cost of insuring against a Greek default rose to a record. The finance ministry started a criminal investigation into bank employees spreading rumors of an imminent restructuring.
In fact, Greece should have celebrated the anniversary of the rescue package in a different way -- by announcing it was repudiating some of its debts.
The sooner Greece imposes a haircut, to use the financial market’s term for losses incurred in a default, the better it will be for everyone. Delay leads to bigger haircuts, and economic research suggests the bigger the haircut, the worse the pain that follows. The damage being inflicted on the Greek economy is too great. And once defaults within the euro area are accepted, a sensible conversation about how to fix the single currency can begin.

Over the last week, the prices in the market make it clear that most traders have already concluded that a Greek default is a done deal. The yield on two-year Greek debt rose higher than 22 percent at the end of last week. Only the most sharkish credit company charges those kinds of rates. Ten-year bond yields are now close to 15 percent. The cost of insuring Greek sovereign debt jumped to a record, with the prices of credit- default swaps now suggesting there is a 67 percent chance of default.

No Point

In reality, there isn’t much point in buying the protection. It’s like insuring yourself against the possibility it might rain in London in the next year. It’s going to happen; it’s just a question of when.
Officials in Athens and Brussels are still insisting that default isn’t an option. They should quit pretending. Here’s why.
The markets portray defaults as catastrophic, mainly because the bankers and fund managers who provide most of the commentary stand to lose a lot of money. In fact, countries fail to pay back their debts all the time. What does make a difference, however, is the size of the haircut.

Future Punishment

A paper presented at the Royal Economic Society conference in London this month by Juan Cruces and Christoph Trebesch studied all the debt restructurings between countries and foreign banks and bondholders since 1970 -- a total of 202 cases in 68 nations. It found that “restructurings involving higher haircuts (lower recovery rates) are associated with significantly higher subsequent spreads (borrowing cost) and longer periods of capital market exclusion.” In other words, the worse the losses inflicted on the bondholders, the more the markets will punish you later on, and the longer it will be before you can access the capital markets again.
Greece’s debt position is worsening. Delay isn’t an option. It would be better to impose a 40 percent or 50 percent loss on bondholders this year than a 70 percent or 80 percent loss in 2013.
Next, the damage being inflicted on the Greek economy right now is catastrophic. Unemployment is set to rise above 15 percent this year. The central bank estimates the economy will shrink by another 3 percent in 2011, even though the rest of the global economy is experiencing a sustained if modest recovery.

Spending Cuts

The government is still reducing spending -- another 22 billion euros ($32 billion) of cuts were announced this month -- which will only depress the economy further. There is very little sign yet that exports can make up for the fall in domestic demand. You can’t just cut your way out of this crisis. At some point, the Greek economy needs to start growing again. So far, no one has explained how that is going to happen.
Lastly, once Greece has defaulted, a serious conversation can begin about how to reassemble the euro area. Plan A was to rescue Greece, arrange a bailout, get the country back on track and stop the contagion. It’s as clear as day that it hasn’t worked. Greece isn’t showing signs of recovery, and both Ireland and Portugal have had to apply for bailouts as well. If that doesn’t persuade people to switch to Plan B, it’s hard to know what will.
Greece should bow to the inevitable, announce a 50 percent haircut on its debt and impose a three-year suspension of interest payments on what remains outstanding. Bondholders could be offered further payments, linked to economic growth, so that as Greece recovers, they get a bit more of their money back.
With the money saved on debt repayment, Greece could start restructuring its economy, putting demand back into the system, and focusing on creating the competitive export industries that are the only thing that will enable it to survive within the euro. The rest of Europe could stop fighting a losing battle to rescue Greece from default, and start concentrating instead on how to make the euro area work better.
There is no point in drawing out the agony any longer --and certainly not until the second birthday of the bailout package. It should be done by the end of May, and then everyone can move on.
(Matthew Lynn is a Bloomberg News columnist and the author of “Bust,” a book on the Greek debt crisis. The opinions expressed are his own.)
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To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net
To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net