The basic issue in Europe is that Governments have borrowed to consume yesterday and now they need to find someone to pay today. Why not pass the parcel to the Banks? After all, they are used to corporate debt writedowns, and a Sovereign is just the same, right? Not exactly …
There are three steps in a corporate restructure:
1. The parties agree that payments cannot be met from current cashflow
2. Assets are sold to raise cash or are re-priced
3. New claims are issued
The EU’s proposed Greek restructure clearly misses Step 2. Lenders have always known that they cannot repossess a country and so have foregone Step 2. in the expectation that the Sovereign entity will not abuse the privilege. This means that the Country is expected to raise the cash rather than walk away.
Not wanting to foot the bill for Greece, the EU has chosen the short-term opportunistic route and asked the banks to take a voluntary haircut. The carrot is access to Government support while the stick is raising capital requirements. But will this short-term opportunism lay the grounds for longer-term regret? My guess is that it will …
Having accepted a bondholder writedown when the underlying assets are clearly there to cover the debt, what should a bank do in the future? The extreme position is to cut off lending to EU Governments, which is what many foreign banks will do. The majority of the large financial institutions will realise that they did not price the EU’s non-payment risk appropriately and that there is no reason to trust the organisation going forward. Accordingly, a permanent higher credit charge will need to apply to EU Governments seeking to borrow. This charge could run to several percentage points higher than at present. The upshot is that the EU will have to bear the cost over the longer term from their short-term money grab.