Rollover? Haircut? Greece faces ugly choices

 david parkinson From Wednesday's Globe and Mail

Published Tuesday, Jul. 12, 2011 7:29PM EDT

It’s becoming increasingly apparent: Greece is not going to be able to avoid a debt default – even if the default hides behind another name.

While the troubled thorn in the European Union’s side could muddle through for a while on EU bailouts, belt-tightening and blind faith, economists and bond-market strategies say the numbers are not on Greece’s side.

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It has €330-billion ($445-billion) of outstanding debt and its economy is shrinking, meaning its already wildly unsustainable debt to gross domestic product ratio of nearly 150 per cent is getting bigger by the day.

The possibility that Greece can grow its way out of even its immediate debt quagmire is all but non-existent. More extreme measures will be needed – some more painful than others, but they’re all going to sting.

The most palatable option to many investors is a so-called “rollover,” which would see Greece replacing debts that are nearing maturity with new, longer-term bonds. That’s the essence of the plan championed by France’s banking association, which proposes that investors pledge to invest a large portion of the proceeds from maturing debt in new bonds with either five- or 30-year maturities.

Many observers like this because, at least technically, it doesn’t require creditors to take a “haircut” – the market’s euphemism for wiping out a large portion of the debt owed to the creditors. This would be particularly attractive to Europe’s banks, who fear having to take deep writedowns on their balance sheets if they were to accept haircuts on the value of their Greek bond holdings – something that could be deadly to many banks still recovering from the 2008 financial crisis.

But bond-rating agency Standard & Poor’s Corp. said last week that it would consider such a plan a de facto default event anyway, because taking on new debt with much longer maturities would effectively make it worth considerably less than the old debt. It might not be a true haircut, but it would ultimately have a similar effect.

Still, rollovers could buy the Greek government some breathing room while it waits for a healthier time for both the economy and the banks. Greece might consider this type of plan for the debts maturing between now and the end of 2013, which amount to just under €100-billion.

The longer-term problem, however, is that a rollover wouldn’t change Greece’s total debt levels – they’d still be out of control.

In the near term, said economist Jonathan Loynes of London-based economic research firm Capital Economics, Greece needs to at least get its debt-to-GDP ratio shrinking instead of growing. But with a contracting economy and a government deficit of roughly 7 per cent this year, the prospects of reversing the course are between slim and none.

That’s why most experts see a rollover as merely a first step – to be followed by a bond haircut.

“There’s no magic trick to solving sovereign insolvency. At the end of the day, it always comes down to haircuts,” said Alex Bellefleur, financial economist at Brockhouse Cooper in Montreal.

Based on current market prices for long-term Greek government debt, the markets have already priced in a haircut of 45 euro cents to 55 cents to the euro. That’s close to the norm in sovereign debt restructurings and defaults over the past couple of decades, in which typical recovery rates for bond holders ran in the 30- to 50-per-cent range – which is also where S&P has pegged its recovery rating on Greece’s bonds.

A 50-per-cent haircut would also be about in line with what would be needed to bring Greece back to long-term sustainable levels. Economists figure it would need to shed about €140-billion of debt to get its debt-to-GDP down to the 85-per-cent average of the rest of the EU, and as much as €170-billion to get down to the 60-per-cent “limit” prescribed by the EU for all its members (which, obviously, has many exceptions).

If Greece is unable to get any plan in place to stop the bleeding, it’s unclear when, in fact, it would slip into a default. It may be able to scrape by until the end of 2012, but could hit the wall when its June, 2013, bonds come due.

Rollover? Haircut? Greece faces ugly choices - The Globe and Mail