Is a Greek default so bad for Greece?
- 29 June 2011
- From the section Business
Sir David Tweedie, the retiring head of the International Accounting Standards Board, told this morning's Today programme that he feared banks were still not putting aside enough money in provisions to cover the significant risk that at some point Greece will default.
As you might expect, he blamed the banks themselves for a wilful refusal to do what's right and prudent, rather than accounting standards which some argue have been defective for not putting more pressure on banks to set aside money to cover the risk of losses on loans that the banks intend to hold to maturity (or loans in the so-called banking book).
The bank accounting issue has been explored here a few times before.
But the important point today is that it explains why eurozone leaders and the European Central Bank are so keen to avoid what bankers call a "credit event" in respect of Greek government debt: if there were a default by the Greek state even on a tiny element of what it owes, bankers would be forced in one fell swoop to write down the value of their loans to the government and probably take losses on associated credit too.
Now total loans by non-Greek banks to the Greek public sector are $54bn on the basis of the latest figures from the Bank for International Settlements and a further $11bn has been lent by international banks to Greek banks.
It's reasonable to assume, most analysts say, that banks would have to write down the $54bn and the $11bn by half in the aftermath of a Greek default - since half of what it owes may be what Greece can afford to repay in the long term, and because a Greek default would probably force Greek banks into insolvency.
Or to put it another way, international banks would at a stroke face losses of around $33bn.
Now the head of one major bank told me his institution had already made a 15% provision to cover the risk of default by Greece.
So on the assumption that its behaviour has been typical, the immediate loss for banks from a Greek default would be around $23bn.
But that's by no means the end of the story.
It's very interesting that a memo from the Federation Bancaire Francaise (the French Banking Association) on the voluntary scheme proposed by France to roll over Greek government debt - leaked yesterday to FT Alphaville - says that it is "critical" that the roll-over scheme should "prevent credit event (sic) on Greek CDS".
A CDS or credit derivative is a contract that pays out to the holder when a creditor defaults: it is insurance against loans going bad.
So plainly there is a fear among eurozone governments that the losses faced by the banking system would multiply from claims made on CDSs.
That said, it is difficult to quantify the potential additional hit. BIS figures say international banks' potential exposure to Greece is $61bn - including $44bn of guarantees extended and $7bn in derivative contracts.
And as I've mentioned before, more than half of that potential exposure, or $34bn, is with US banks.
Anyway, long story short, in a worst case where Greece defaults and banks are forced to take writedowns on all their loans to Greece - including private sector and bank loans - and where there's damage too from potential exposure, the international (non Greek) banking sector is looking at losses of more than $100bn.
Which is a non-trivial sum to lose for banks that are long way from being back to full health after the great crash of 2007-8.
And if you are curious about why France and Germany appear to be the bosses of the process of attempting to secure Greece's financial future, it is not just that they have the biggest economies in the eurozone: their banks have the most to lose from a Greek default, with French banks most exposed.
Also, as I've mentioned before, that $100bn of potential losses for non-Greek banks becomes multiplied by many times if a Greek default were to spark more acute financial woes for the dominoes next in line, Ireland and Portugal.
And if the Spanish domino also started to wobble, well let's not dwell on that hideous possibility.
So it is blindingly obvious why eurozone governments would prefer that Greece didn't just run out of money to pay its creditors in an unplanned and chaotic way.
But what about Greece itself? Well here's the curious thing. It may well be insane - or indeed "suicide", in the words of Greece's central bank governor - for the Greek parliament today to vote against the proposed austerity package and thus in theory cut itself off from the eurozone's and IMF's credit lifeline.
Apart from anything else, it is quite hard to argue that Greece would be advised to continue living way beyond its means, which its intractable public-sector deficit of around 10% of GDP shows that it is doing.
However the fundamental reason for doing what France and Germany want, right now, may be slightly different from the official explanations.
Wait and see
Here's the thing: if the Greek government were to miss a payment on a bond as it fell due, the immediate impact on the finances of the Greek government would be considerably less than the trauma that such a default would cause for the international banking system.
According to bond-market experts, banks and investors who've provided much of the €340bn that the Greek government has borrowed in total would have to whistle for the rest of their money - because a default by Greece would not be the equivalent of a default by a private-sector company.
When a company defaults, the creditors are automatically in the driving seat, and - usually - can demand all their money back.
The legal advice to creditors of Greece however is that they have no such power.
If Greece were to miss a payment of interest or principal on a Greek bond, creditors could sue for the missed payment.
But there seem to be no clauses in the prospectuses for Greek government bonds that would trigger accelerated payment of the rest of what's owed on any particular bond in default or that would put other bonds into default: in the jargon, there are no accelerated payment or cross-default clauses.
So in the aftermath of a default, creditors would in theory have to sit still and wait over many years to find out what Greece either could or would want to pay back.
And, what may be even more troubling for Greece's creditors, most of the bonds are issued under Greek law, not international law.
So in theory if cross-default or accelerated payment clauses were unexpectedly to turn up in bond documentation, the Greek parliament could legislate to make them null and void.
Or to put it another way, in the immediate aftermath of a Greek default, the Greek government would have quite a lot of power to dictate restructuring and repayment terms to its creditors.
Greece could choose to pay back more-or-less what it thought it could afford to pay back.
Why then is the Greek prime minister so adamant that default must be avoided? Is this a manifestation of fraternal solidarity with his eurozone partners?
Possibly not entirely.
Right now Greece needs to borrow money from the rest of the eurozone and from the IMF not just to service the interest and principal payments on its debt.
It also needs the emergency credit to pay the wages of its civil servants and to keep the lights on in schools and hospitals.
Greece has what economists call a primary fiscal deficit, in that what it raises from taxes does not cover the basic running costs of the state, let alone its borrowing costs too.
So Greece can't afford to stick two fingers up to Germany, France and the eurozone and announce a unilateral decision to default. If it were to do that, the vital apparatus of the Greek state and the Greek economy would grind to a halt.
That's true now. If however Greece's austerity measures were to turn out to be successful in reducing Greece's primary deficit - such that it was able to pay all the costs of the police force, schools, hospitals and so on from tax revenues - then at that point Greece would be less dependent on the putative generosity and charity of its eurozone neighbours.
You will know that there are economists who believe that there's no chance the austerity package will reduce the primary deficit to nil, because of how it may be putting the Greek private sector into a death spiral.
But let's assume those economist are wrong and the Greek premier is right.
If that were the case, it could still be misguided to see a vote today for the austerity package as the moment when Greece avoids default.
If Greece's parliament goes for the package of cuts, tax rises and privatisation, that may be the start of a process to make a Greek default affordable and bearable for Greece.
Or to be more explicit, the moment that Greece reduces its primary deficit to zero - the moment that the government can fund itself from revenues levied on its own people - is the moment when Greece is most likely to decide to default on what it owes overseas investors and banks.