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Eric Reguly

Greece should just end the debt dance and default Add to ...

The European Union, the International Monetary Fund and the Greek Finance Minister should admit it: Greece looks bust, bankrupt, broken, doomed. It is not allegedly resting or stunned like the parrot in the Monty Python sketch; it is dead, pushing up daisies, an ex-solvent country.

We know this because Greece: a) sued for a €110-billion ($147-billion) bailout last May from the EU and the IMF; b) the yield on its 10-year bonds has reached distress levels in spite of the bailout; c) its debt to gross domestic product ratio has climbed to gruesome levels; d) its economy is uncompetitive and in recession; and e) the austerity programs are being treated to a social backlash, meaning more cutbacks could be fatal to George Papandreou’s socialist government.

So what was the point of throwing good money after bad? All the bailout did, apparently, was deepen the crisis by piling more debt onto a country that has no hope of paying it off, barring an economic miracle. What Greece plainly needs to do is default and restructure its debt. Ireland, the euro zone’s second bailout victim, and Portugal, itself close to debt calamity, may have to do the same at some point.

Sovereign defaults are much more common than you might think. Some countries seem to do them out of habit, just as U.S. airlines plunge into Chapter 11 bankruptcy protection with regularity, only to fly again. Moody’s, the debt rating agency, did some research on defaults last year and crowned Venezuela the debt default champion, with 10 episodes since independence in the 1830s (yet it’s alive and kicking today). Since the Second World War alone, there have been 108 defaults, among them Argentina in 2002 and Ecuador in 2008.

High debt, unsurprisingly, is one of the traditional default triggers. According to economists Kenneth Rogoff and Carmen Reinhart, countries that defaulted over the past 40 years had an average debt-to-GDP ratio of 70 per cent. Greece’s is estimated at 150 per cent this year – triple Canada’s level – making it the highest among the 17 euro zone countries. The European Commission expects it to rise again next year. The last time Greece’s debt was less than 100 per cent was in 2004. Debt growth of this scale is unsustainable even in good times let alone a recession.

Greece’s financial horror story was well known this time last year. Yet the bailout came anyway and the loot failed to prevent the debt contagion from rolling across Europe. Ireland required a bailout in November and rescue missions for Portugal, Belgium and Spain are not out of the question.

EU finance ministers are in a low-grade panic about the adequacy, or lack thereof, of their €440-billion bailout fund. It’s clearly not big enough to prevent bond yields from rising, even in the bailed-out countries. On Wednesday, the yield on Greece’s 10-year bonds was 11.6 per cent, putting the gap, or “spread,” over benchmark German bonds at an astonishing 8.6 percentage points. Even if the fund were doubled in size, there is no guarantee the bond vultures would flee. Once a rescue is launched, they might simply target the next weakling and pound it into the dirt.

Defaults aren’t simple. They come with a myriad of legal, political and financial problems, such as the damage to investors who hold sovereign debt, notably the banks. Euro zone leaders would fear that a default, even in a country as small as Greece, would destabilize the already shaky euro. National shame would come with a default.

Still, a default looks like the only sensible option as Greece sinks into the debt quicksand. Historically, investors lose about half the value of the bonds in a restructuring, according to Moody’s. Greece might be tempted to negotiate a mere 30-per-cent “haircut” on its debts, on the rationale that anything greater might clobber the weakest euro zone banks, as well as its relationship with investors.

But given Greece’s dire financial condition, anything less than a 50-per-cent haircut might not do the trick. If Greece’s debt-to-GDP ratio goes to 160 or 170 per cent by 2015, as it easily could, the government would be devoting close to 10 per cent of its GDP to interest payments, mostly to investors who don’t live in Greece. Watch the protests and riots explode in the streets of Athens when that much wealth is siphoned off. A Greek default may be socially as well as financially expedient. And one thing is for sure: The longer a default is delayed, the more painful it will become.

 

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