Weighing a Second Greek Bailout

Greece will undoubtedly receive a second bailout from the EU and IMF. But expert Daniel Gros says it remains to be seen whether default is inevitable and if banks and other private bondholders will also take a hit.

June 10, 2011

To help readers better understand the nuances of foreign policy, CFR staff writers and Consulting Editor Bernard Gwertzman conduct in-depth interviews with a wide range of international experts, as well as newsmakers.

A little over a year after the EU and IMF provided Greece with a €110 billion bailout package, the country is looking to its more solvent neighbors--particularly Germany--for yet more financial aid. An important issue is how to create an "orderly insolvency" so as not to disrupt financial markets, says Daniel Gros, director of the Centre for European Policy Studies in Brussels. But Gros thinks a German plan for a bond "rollover," coupled with another bailout, will only "push the can a little further down the road." One significant issue, says Gros, is the political sustainability of any option, in Greece and for its creditors.

How solvent is Greece?

On most metrics, Greece is insolvent in the sense that it probably would not be able to generate the large budget surpluses that would be required to fully service its debt in the long run.

Is another bailout of Greece essential for the preservation of the eurozone?

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The key issue here is how to be able to stop a further bailout without having our financial markets break down.

A full, disorderly insolvency of Greece tomorrow would probably be very costly. An orderly insolvency to manage our next month would be of very little cost in terms of financial services, and would actually help to preserve the eurozone in the long run. Any government insolvency will, of course, disrupt financial markets and services in the short run and, therefore, somehow increase uncertainty in the short run.

What role, if any, should Greece’s private-sector creditors play in alleviating the country’s debt crisis?

Private creditors, in my view, have only one goal--mainly, to get their money back. You cannot expect them to be all things for the greater good of eurozone stability. That you have to expect as a fact. Therefore the only role really to have is that somehow they have to be brought to the point where they do accept that part of their claim will not be satisfied.

The Germans are calling for private creditors to accept a so-called debt exchange before committing to financing another Greek bailout. What exactly are they asking for?

The debt exchange that is now being asked from Germany is basically only rollover maturity for the banks. Say, instead of getting my money back tomorrow, I’m willing to wait for seven years.

Do both a "rollover" and true debt exchange--where a creditor’s current bonds are replaced with new bonds with different maturities--amount to a restructuring of Greece’s debt? Do they both ultimately result in default?

The first option [a rollover] results probably in a technical default and does not really alleviate the debt burden for Greece. So it’s basically pushing the can a little further down the road. And [with the true debt exchange] the problem will not be smaller than a true debt restructuring . . . leading to default. Probably, it [a rollover] will not have the same economic impact and regulators can treat it differently, and therefore it is much to be preferred.

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Is restructuring inevitable? Does pushing it down the road make the fall that much harder?

"If Greece says that I won’t pay anymore, that of course would create really severe problems and might destabilize markets--and might be something like a second Lehman event."

That is certainly the direction we are going right now, because if Greece gets another package then its final public debt would be even higher in two or three years. And, therefore, I’m very skeptical that a further bailout would actually solve the problem. The key issue is one of political sustainability--in Greece and on the side of the creditor countries. Actually, here the United States plays a very important role because it is quite clear that if the United States puts its full political weight behind the position that Greece should be bailed out, then the German government will probably oblige.

The European Central Bank has been quite outspoken with regards to any restructuring, even the seven-year maturity extension proposed by the Germans. How will this debate pan out?

Well, this is in essence a fiscal issue that is decided by finance ministers. The ECB only has a consulting role [in this situation], and, therefore, there doesn’t really have to be a formal compromise between the ECB and the government. And, probably, the ECB will say this is your decision, but we warned you; though it would probably push for something that does not force rating agencies to assign a default rate to Greek bonds.

If Greece were to restructure and default, what are the consequences for the rest of the eurozone?

This all depends on how Greece restructures and defaults. It would require a debt buyback at market prices for the fallout in the market to be quite limited. If Greece, just like Argentina [in 2002], says that I won’t pay anymore, that of course would create really severe problems and might destabilize markets--and might be something like a second Lehman [Brothers] event.

What are the consequences for the eurozone periphery, including countries like Ireland and Portugal that have already received bailouts?

Formally, Ireland and Portugal don’t need to access the markets today. So, even if the price of the existing bonds goes down, it doesn’t really have an impact. It might of course be that these countries will need additional [aid] packages because they will not be able to access the markets again next year. Over time, it will be become very clear that the fundamentals of these countries are different; they are much better. Therefore, ultimately, these other countries will be able to pull through. Portugal has only about half of the public debt that Greece has. And with Portugal, the problem is not so much the public debt, but it is the fact that the private sector has accumulated a lot of foreign debt. With Ireland, I think it is a completely different case. Ireland has nearly no foreign debt as a country. The government has lots of foreign debt. But the private sector--basically the pension funds--have lots of foreign assets. If the government just tells the private-sector pension funds, "please buy government bonds," then the Irish problem could be resolved almost overnight.

Are other countries, such as Spain and Italy, at risk of contagion?

Certainly. But here, again, you have to distinguish between the short and the long run. In the short run, there would certainly be contagion. But the fundamentals of these countries are quite different and, therefore, I would expect that the contagion for Italy will remain limited. For Spain, I’m not so sure because there’s a risk that Spain will also experience similar problems as Ireland.


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