What’s Behind the Squabble Over a New Aid Package for Greece?

by Jacob Funk Kirkegaard

Ptererson Institute for International Economics
June 10, 2011

As euro area members jockey over who will pay to keep Greece afloat in the next two years, political grandstanding by elected leaders is to be expected. A lively display of those tactics is under way ahead of the euro area and European Union (EU) meetings later this month, from June 20 to 24. So are the various countries’ maximalist negotiating positions, outlined for domestic consumption, in discussing possible new terms for the EU-International Monetary Fund (IMF) bailout program.

The German Finance Minister, Wolfgang Schauble, went down the maximalist route, for example, in his June 6 letter to the European Central Bank (ECB), the IMF and the euro area finance ministers. Germany demands a "fair burden sharing between taxpayers and private investors" and a process that "has to help foster the Greek debt sustainability," he wrote. Specifically, Schauble outlined in his letter that as far as Berlin was concerned:

This means that any agreement on 20 June has to include a clear mandate — given to Greece possibly together with the IMF — to initiate the process of involving holders of Greek bonds. This process has to lead to a quantified and substantial contribution of bondholders to the support effort, beyond a pure Vienna initiative approach. Such a result can best be reached through a bond swap leading to a prolongation of the outstanding Greek sovereign bonds by seven years, at the same time giving Greece the necessary time to fully implement the necessary reforms and regain market confidence.

The "Vienna Initiative approach" rejected by Schauble refers to the move by European banking authorities to persuade European banks to permit Eastern European countries facing insolvency in 2008 to roll over their debts. The clear message is that Germany is demanding a genuine bond restructuring that will merely make Greece’s default orderly as opposed to "the first unorderly default within the euro zone."

On the other side of the table sits the ECB, which explicitly opposes the demands for haircuts to private bondholders at least for the time being. The central bank has clearly stated a maximalist pre-meeting negotiating position that in the event of a Greek default, i.e., a restructuring, Greek government bonds will no longer be eligible as collateral with the ECB. Such an occurrence would inevitably trigger a collapse of the Greek banking system, as the Greek government does not have the resources to recapitalize their banking system to the extent that Greek banks can. The government thus lacks the ability to regain access to private market liquidity. The ECB will only accept a purely voluntary bond rollover, which it clearly does not view as a restructuring. Banning any Greek collateral after a restructuring is ultimately another way to achieve "the first unorderly default within the euro zone."

As usual, such talk makes a Greek collapse and a crisis in the euro zone seem inevitable.

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