The ECB’s decision to lend very large sums of money to banks has for the time being quietened the Italian and Spanish bond markets, despite S and P downgrading various sovereign bonds. Meanwhile, trouble is blowing up again in Greece.
Before Christmas one of the Euro crisis summits decided that Greece could negotiate a voluntary “haircut” with private sector Greek bondholders. The deal was advertised that those companies and individuals that had lent Greece Euros would get back one half of what they had lent. The aim was to get a voluntary agreement to this deal. That way the public sector owners, like the ECB, could be let off their share of the losses, and the banks and others that had insured this debt against default would be spared having to pay out, as it would not count as a formal default.
Recently negotiations to agree the detail and tie in all the private sector holders of Greek debt have got into difficulties. Apparently when the full terms of the proposal were set out, the “haircut” turned out to be rather more than 50%. For every 100 Euros lent to Greece a private lender would get back just 15 Euros in cash when the debt fell due. Another 50 Euros would be cancelled. The remaining 35 Euros would be “repaid” in the form of a 30 year bond or promisory note. They are arguing over the interest rate on such a note. If you took the market rate you would be talking 30%. Some thought they would be offered 5%, but others think Greece can only afford 2-3%. No wonder the private sector creditors are none too happy. This is not so much a haircut, more a scalping.
None of this is helpful to the stability of the Euro zone. I guess I am one of the few still shocked by the idea that a rich advanced western country can think it fine to refuse to repay its debts in full and on time. It does not make it any easier for that country to return to the markets to borrow money in the normal way at realistic rates of interest any time soon. Looking at the market ratings, and the views of the Ratings Agencies, there are now doubts spreading about Portugal’s ability to repay all her debts on time and in full. Portugal needs to convincingly quell these market fears if she is to return to normal borrowing and get out of special measures and subsidised loans.
The injection of large quantities of liquidity into the banking marketplace by the ECB can provide some temporary respite in some cases. It does not deal with the two underlying harsh realities. Many countries within the Eurozone are spending and borrowing too much, so they cannot borrow in normal markets at affordable rates. Many Euro countries are not competitive with Germany, or many other parts of the world, at their current level of costs and current rate of the Euro. There is no easy mechanism within the zone to route the German surpluses into the deficit countries to pay the bills.
Until these two structural problems are solved, the application of liquidity can delay the crisis but not prevent it. Indeed, it just makes the debts and deficits larger when finally they do get out of control. The policy prescriptions of higher taxes and lower spending do not help the economies recover. The public sector retrenchment is not linked to policies to promote private sector growth. Instead the increasing tax burden and the growing regulatory burden makes it more and more difficult for the private sector to respond positively. When you add in damaged banks, it remains a toxic mix.