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Other shoe has yet to drop in Greek drama

In their perpetual search for juicier yields, risk lovers of the world have been flocking to bonds issued by a government that will undoubtedly have to rely on the kindness of its unhappy euro partners to meet its most pressing obligations in the coming months.

That would be Greece, where the link between reality and public finances has always been tenuous at best.

Or, as one Mark Twain-loving German headline writer put it last month:

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"Lies, Damned Lies and Greek Statistics."

Yet last week, as euro-skeptics rubbed their hands in I-told-you-so glee and policy makers in Berlin and Paris fretted over how to keep the Greek fiscal crisis from bringing down the euro zone's shaky scaffolding, the bond market proved remarkably receptive to more Greek debt.

International investors snapped up €5-billion ($7-billion) worth of bonds bearing 6.37 per cent interest, more than double the return on equivalent German paper.


Of course, the beleaguered government has to raise another €15-billion to cover maturing debt by the end of April and about €33-billion more for the rest of the year. And if it has to keep forking out huge premiums to get people to take the bonds, its depleted coffers may never recover.

Here's one sobering statistic (not provided by Athens) that illustrates the mess Greece faces for years to come, regardless of how much austerity it can force upon its recalcitrant public service. By next year, says Marko Papic, Stratfor's able geopolitical analyst for the region, Athens' interest costs alone will amount to about 6 per cent of GDP annually.

Yet, for now, investors are betting that Greece's euro partners will do whatever is necessary to keep the country from defaulting. And in the meantime, they can rake in those fat premiums.

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Is it a sensible bet? Not really, says Edward Altman, a finance professor at New York University's Stern School of Business and a leading authority on distressed debt. The Z-score model he devised in the 1960s is still widely used to assess the probability of corporate defaults and failures.

Investors lured by the siren song of yield obviously see Greek bonds as an attractive opportunity and have concluded the risk of outright default is low. "I think that's shortsighted," Prof. Altman told me. "Basically, I'm fairly pessimistic about the outcome."

He was in Toronto last week to deliver a lecture on credit market conditions to legal types and other insolvency fans at University of Toronto's law faculty. His view of the corporate junk bond world is much more sanguine than that of potential sovereign deadbeats and the risks they pose to the global market.

His models forecast only a 6.7-per-cent default rate this year on U.S. and Canadian corporate junk bonds - and that's if the economy fails to recover. If growth picks up, he predicts the rate will be only 4.3 per cent. That compares favourably with the historic average of 4.5 per cent and the 2009 total of nearly 11 per cent. The situation will worsen markedly in 2011 and beyond, as massive amounts of debt come due. But that's another story.

Greece won't survive that long financially without some form of bailout, which Prof. Altman and other debt-watchers agree is inevitable.

One of many "creative solutions" - along with direct subsidies from a mix of private and public institutions in Europe - would see banks and other major creditors taking a haircut on their Greek debt.

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"But this will only work in the short run. It's almost like a distressed exchange [in the corporate world]"

Creditors accept, say, 70 cents or less on the dollar, and the debtor avoids bankruptcy. Or in the case of Greece, a devastating default that would reverberate throughout global credit markets and quite likely trigger another meltdown.

Sounds good, no?

Not really. Prof. Altman's extensive research shows that at least half of all distressed exchanges end up in bankruptcy anyway within two to three years. And he has no doubt Greece is headed that way, too.

A bailout of sorts would only provide temporary relief, he says. The euro would likely strengthen and European stock markets would rise. But then, six to 12 months from now, "the reality will set in that it wasn't enough. And they will try again or they'll just throw up their hands and say: 'The German people won't accept bailing you out again.'"

The reason: is that Greece faces fundamental structural problems that cannot be covered up with a bailout Band-Aid.

"Greece will default, and it will lead potentially to some systemic problems in other countries, namely Spain, Italy and Portugal to start with. And it could even spread to the U.K."

So get it while you can, yield hunters. The party isn't going to last long.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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