Streetwise Professor

October 18, 2011

I Guess It Will Take More Than a Week

Filed under: Economics,Financial Crisis II,Politics — The Professor @ 10:59 am

Over the weekend, the G-20 gave an ultimatum to Europe:  Fix your problems in eight days.  I guess the Euros should have been grateful: the G-20 gave them two more days than it took God to create the universe.  Presumably they were looking forward to a rest on the ninth day.

But no sooner speaketh the G-20, than Merkel and Schaeuble speaketh: In your dreamsToday, Merkel said that talks are moving “by the millimeter.”

Not surprisingly, the hangup is distributive: who pays?

German officials have said in recent weeks that the eurozone needed to find a solution for Greece that makes the country able to repay its debts in the long-run.

France on the other hand has been reluctant to back bigger losses for banks, since French banks are among the biggest holders of Greek government bonds.

Its position is supported by the European Commission, the EU’s executive. Commission officials said last week that technical revisions to the July deal with the banks are necessary because changed market conditions had made the deal more expensive for Greece and the rest of the eurozone.

While that could imply an upward revision of the losses for banks, cuts would likely stay far below the 50 percent to 60 percent haircut pursued by the Germans.

That’s the fun of trying to negotiate an insurance (i.e., loss sharing) deal after the accident.

But the Franco-German dispute does point out a fundamental problem.  Any realistic plan would involve a big haircut.  In rough numbers Greek debt is about 170 of GDP, and it can probably afford to support 80-85 percent.  So, a 50-60 percent writedown is ballpark: the 21 percent number negotiated in July was wildly optimistic, and no longer operative.  But a 50 percent writedown will hit some banks hard: they will be undercapitalized, most likely.  So where is new capital going to come from?  If the French government injects capital into French banks, that will hit French national credit.  So the French want to Europeanize the solution–and since the Germans are the Europeans with the most money, that means “Germanize” the solution.  Which is hardly palatable to the Germans.

So statements about forcing the bondholders–which are disproportionately banks–pay sound great, but that just relocates the problem.

And remember folks.  This is Greece, which is just the opening act.  So don’t dream about a deal by October 23.  And even if a deal gets done in the relatively near term, it won’t be the last deal.  I’m not saying that the Europeans are checkmated, but it’s just very hard to see how they can actually prevail in this game.

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