What price a Greek haircut?
One of Europe's most influential bankers said to me the other day that he thought it would be a disaster if any of the eurozone's debt-stretched nations imposed a reduction in the value of their respective sovereign borrowings, or - to use the jargon - took a haircut on their debts.
For him, the eurozone approach of muddling through - providing IMF and eurozone loans to those countries that cannot borrow on markets - is the right approach, even if it hasn't actually solved anything for the eurozone in a permanent sense.
It is curious he should take that view, given that the rescues of Greece and Ireland that took place last year are already having to be renegotiated. And the bailout of those countries didn't stop the rot: Portugal is well into the process of obtaining emergency finance from eurozone and IMF.
Wouldn't it be better to cut what Greece - or Portugal or Ireland - owes down to a manageable size, in tandem with the imposed shrinkage of its public sector, to put its public finances back on a basis that is sustainable for the long term?
The markets are saying that's the only way forward. Over the course of a year, the market price of Greek government debt has fallen by more than half, for example. The yield on 10-year Greek government bonds is well over 15%. Which is an unambiguous statement from investors that there is not the faintest chance that they will lend to Greece again, unless and until its debt burden is reduced to a manageable size.
Or to put it another way, markets are presenting a simple choice to eurozone government heads and the IMF: they can continue to lend to Greece for an indefinite period, in the hope that Greece's economic growth will eventually pick up and generate incremental tax revenues, which would allow the Greek government to perhaps start paying down its debts; or they can bite the bullet and put Greece into the equivalent of what the Americans call Chapter 11 bankruptcy protection, to restructure and reduce what Greece owes so that it is consistent with the market price of all that debt.
Now as of this instant, option one looks a bit naive, in that what's happened subsequent to the first bailout of Greece a year ago is that its ratio of debt to GDP has been growing in leaps and bounds to more than 150% of GDP (and for more on the heroic challenges faced by Greece, see reports in the next day or two from Stephanie Flanders, who is in Athens).
So you would have expected my influential banker - who knows a thing or two about the markets - to be in favour of what the markets are saying is inevitable. Surely he should be calling for that most humiliating event for any creditor, a formal admission by Greece that it can't pay what it owes, which goes by the moniker of a haircut, or restructuring, or default?
But Mr Big Banker doesn't think that's the right way forward. His reasoning is that he fears a debt restructuring would weaken many of Europe's banks, such that they would be forced to raise new capital - perhaps from their respective governments. And, for reasons that slightly elude me, he sees that as a worse outcome than leaving Greece trapped in an unbreakably vicious cycle of economic decline.
The odd thing, however, is that the official statistics really don't seem to indicate that a haircut on Greek debt would be Armageddon for Europe's banks.
It would be a disaster for Greece's banks, that's certainly true, given that (according to Bank of England figures) a 50% writedown of Greek sovereign debt would wipe out more than 70% of their equity capital. Or to put it another way, they would be bust and would have to be recapitalised.
But, sooner or later, Greece's banks are going to need strengthening in any case. Fixing Greece's public finances won't fix Greece unless its banks are mended too. So any estimate of the costs of rehabilitating that country will include the price of providing new capital to the banks.
The more relevant question, perhaps, is what a Greek haircut would mean for banks outside Greece.
The latest figures from the Bank for International Settlements, published a few days ago, show that at the end of last year banks outside Greece had lent $146bn to Greek banks, companies and the public sector - down from $171bn three months earlier. And, of this, loans to the public sector (largely holdings of Greek government bonds) were $54bn.
To be clear, this doesn't take account of exposure through derivatives, credit commitments or guarantees. So the world's banks probably have a further $100bn exposure to Greece.
The sums at risk therefore look serious though not - on their own - potentially disastrous for the health of the financial system.
Now as luck would have it, the banks most at risk happen to be those of the eurozone's two largest and strongest economies, Germany and France. The exposure of German banks to Greece is $34bn, including perhaps $20bn of loans to the Greek government, while the exposure of French banks is $57bn, of which again around $20bn is probably sovereign lending
Now because of what some would say is the madness of how the global Basel rules - that measure the strength of banks - are applied, there would be a double whammy for eurozone banks if there were a write-off of Greek sovereign debt.
The banks with Greek sovereign exposure would have to reduce their respective stocks of capital by the amount of the loan loss. And they would have to inflate the size of their balance sheets, because the residual exposure to the Greek government would lose its official (and some would say insane) zero risk weighting. So the fall in the capital ratios of banks with exposure to Greece would be magnified in a painful way.
Of the larger listed banks, only one, the Franco-Belgian group Dexia, looks as though it would be seriously hurt by a Greek debt writedown. According to Morgan Stanley, Dexia has 4.9bn euros of exposure to Greek sovereign debt, equivalent to more than half the value of its equity capital. Dexia would be significantly weakened by a 50% Greek haircut.
Next at risk, according to Morgan Stanley, would be Commerzbank of Germany, with €3bn of Greek sovereign debt, equivalent to 15% of its capital. Meanwhile BNP Paribas and Credit Agricole of France, Erste of Austria, KBC of Belgium and Deutsche Bank of Germany all have meaningful though not devastating exposures.
Less visible is the Greek exposure of Germany's state backed landesbanks - which regulators tell me is considerable. But if they were to incur large losses on it, Germany could afford to recapitalise them.
So what is going on? Why are eurozone governments so wary of a restructuring or haircut of Greek sovereign debt, given that banks in the round won't be killed by the consequential hit?
There seem to be three reasons.
First, in Germany, it is apparently politically more acceptable to provide rescue finance to Greece directly than to rescue German banks that foolishly and greedily bought Greek debt for its relatively high yield.
Second, a Greek debt restructuring would be a severe blow to eurozone pride in the strength of the currency union.
Third, a Greek haircut might be the thin end of a large wedge. If it created a precedent for haircuts in Portugal and Ireland, the losses for the eurozone's banks would begin to look serious. But again, if there were just a trio of national debt haircuts, if the rot were to stop with Ireland and Portugal, eurozone governments could afford to shore up and recapitalise their banks.
That said, what the eurozone could not afford - or so regulators fear - would be haircut contagion to the likes of Spain and Italy.
But Spain and Italy are looking in better shape. Spain, for example, is taking steps to strengthen its second tier banks and its banks in general have become less dependent on funding from the European central bank (which is a proxy for their perceived weakness).
So here, I think, will be what will determine whether Greece gets its haircut in the next two or three months: if eurozone governments come to believe that Spain is well past the moment of maximum risk of financial crisis, there will be a bold restructuring of Greek debt.
But, to use that awful footballing expression, if they do go for a Greek debt haircut or writedown, it will be squeaky bum time in government buildings all over Europe.