We've been reading a lot about Greece's debt crisis, which has now spread to other countries. How did it begin?
The problem started long before the current situation. Greece has been living beyond its means for a long, long time. In fact, from the time it joined the euro zone, its deficits have been higher than 7 per cent, which is more than double what they're supposed to be to belong to the euro. Greece has structural problems within its economy that it never really resolved. It's a very small economy with a very large public sector which accounts for about 40 per cent of its GDP. It was deficit spending all along and the 2004 Olympics made things even worse.
Then along came the global financial crisis which meant that suddenly Greece was faced with even more severe economic problems and had to come up with more money for social spending, unemployment was rising, and the economy was getting even weaker, which meant it had to borrow more money to keep things afloat. As long as rates were relatively low, they could keep that thing going.
Warren Buffett once said that in a financial crisis you see who's swimming naked. Well, the Greek's have no clothes, and that's been going on for a while. What precipitated this actual crisis is that when the Greeks looked at their treasury, they realized that they didn't have enough money to keep financing their deficit, which is growing alarmingly. Their interest costs are now so high that they account for more than 22 per cent of all government revenues, which means that merely one in four dollars the Greeks collect has to go just to pay the interest on their debt. That's about €1.5-billion a month.
Who are Greece's creditors? Who's going to suffer if it defaults on its loans?
Anybody who's stuck with Greek bonds, that includes foreign institutions, foreign governments, foreign banks, a lot of pension funds, which in fact were attracted to Greek bonds in the first place because they were getting higher yields than they could on other euro bonds. So if you believe the euro's pretty safe, why buy German bonds when you can get much more yield from Greek or Portuguese or Spanish bonds, and that's what attracted people to it, in the belief that there would be no danger of default, and Greece had an investment grade credit rating from the ratings agencies, which made it eligible for a lot of pension fund investments. These pension funds are not allowed to hold any bonds that do not carry investment grade ratings.
What do the high yields of Greek bonds tell us about the credit worthiness of the country?
They tell us that it's not very credit worthy. When you have to pay 24 per cent to get people to buy your bonds, they don't think that your word backing those bonds is worth very much. The real risk of default causes investors to demand those kinds of yields, and only people who play in that sort of market, which is high, high risk bonds, are going to invest in them. Most institutions won't touch them -- they're not allowed to under their own covenants because of the risk attached. Of course, they're now fearing they will get much less than the face value of their investments when they have to cash them in.
The Greeks are not able to issue new bonds with those rates -- they can't do it because they can't afford it, so we're not seeing any new issues. The Greeks are basically being frozen out of the bond market for now. There is going to be, if not a default in actuality, it will be what's known as a soft default, whereby the Greek government negotiates new terms with these creditors and basically says, we can't give you cash for your bonds, but we can give you new bonds for your old bonds. These new bonds will carry higher interest rates in some cases and lower principal payments, in other words, they're going to have to accept less than thought, and there are estimates ranging anywhere from a 30-to-70-per-cent reduction on the actual value of the bonds they hold, and that doesn't mean they get the cash right away. They get new bonds that mature at a later date than the bonds they currently hold.
How is the current crisis connected to the financial crisis of the past two years?