Is France's Greek rescue plan flawed?
- 27 June 2011
- From the section Business
The French Treasury believes it has come up with a scheme to persuade creditors of the Greek government to voluntarily re-lend to Greece half of the money that Greece is due to repay over the next couple of years.
If the scheme is taken up by banks, pension funds and other holders of Greek bonds, the effect would be to significantly reduce the amount of emergency loans that eurozone governments would have to provide to Greece.
The aim would be to cut rescue funds provided by the eurozone by €30bn.
The plan is that as existing Greek government bonds reach their repayment dates, the holders of the bonds would pocket 30% of what they're owed, re-lend 50% to Greece for 30 years and invest the remaining 20% in a so-called special purpose vehicle - which in turn would put the banks' money into high quality, AAA rated bonds.
This may sound complicated. But the idea, borrowed from so-called Brady bonds that were used to help Latin American countries cut their massive debt burdens 20 years ago, is that the funds in the special purpose vehicle would act as a form of insurance, to cover the risk that Greece would eventually default on the the new 30-year loans.
Now there all manner of flaws and uncertainties in the scheme, according to bankers to whom I've spoken (and not all those bankers are from perfidious Albion).
First of all, it is not at all clear where the special purpose vehicle will put its money. If, for example, it invests in the only rock-solid AAA rated government bond in the eurozone, German government bonds or bunds, there would not be a high enough yield - even over 30 years - to cover more than a portion of principal and interest that would be lost from a Greek default.
If investors are right that Greece will ultimately have to write off more than half of what it owes, the returns available on German government bonds could not possibly cover that potential cost.
Which means that any bank participating in the French scheme would surely have to acknowledge that its loans to Greece had been impaired, and it would therefore have to incur a loss - which is precisely the opposite of what the French Treasury is trying to achieve.
The only way for this insurance to be adequate to cover the risk of default would be for eurozone governments to somehow enhance the return available on the SPV's investments.
But that's another way of saying that taxpayers' money would be used to subsidise either the Greek government or the bank creditors' of the Greek government - and that is regarded as politically impossible in Germany.
Second, and this is far more fundamental, some bankers passionately believe that France is traducing the original Brady idea.
The original Brady structure worked, in rebuilding the finances and the economies of excessively indebted countries such as Mexico, Argentina and Brazil, mainly because those countries were permitted to reduce the total amount they owed their creditors.
To use the jargon, there was a haircut of their sovereign debt. So the insurance part of the scheme was used to protect the value of debt that had already been reduced to more bearable size.
The original Brady scheme was a genuine path to recovery for countries that had borrowed far more than they could afford to repay.
By contrast, the new French version is aimed at sustaining the claim - which many bankers and investors regard as a dangerous fiction - that Greece can afford to repay all the €340bn it owes.
Broadly the French scheme would do little more than extend the maturity of Greek debt.
But it would do nothing to reduce the crippling burden of all that debt on Greece.
Its aim is to protect both private-sector lenders to Greece, especially the banks, and public-sector lenders to Greece, such as the European central bank and eurozone governments, from taking losses on their Greek loans.
However, most bankers and investors would say that unless and until private or public sector lenders to Greece - or both - are prepared to incur such losses, and reduce what Greece owes them, then neither Greece or the eurozone will be cured of the great financial disease afflicting them both.