Europe’s Plan Won’t Cut Greek Debt

by Peter Allen, Barry Eichengreen and Gary Evans

Bloomberg
August 5, 2011

Postmortems of last month’s European Union summit meeting have now turned to why the Greek debt rescue failed to restore investor confidence in the country’s finances. Many reasons are advanced: the failure to communicate clearly; the complexity of the plan; the inability to coordinate with the International Monetary Fund.

There’s a simpler explanation: The debt-reduction deal failed because it didn’t reduce the debt.

Instead, Greece gets a reduction in interest rates and a lengthening of maturities on its loan from the European Financial Stability Facility. But that loan also has been supersized, and the country has to pay back the additional official debt.

The government in Athens also gets a 20 billion-euro ($28.7 billion) bond-buyback program funded by the EFSF. But again, the country will have to repay the money used to finance the buybacks, plus 3.5 percent interest.

All this is modestly helpful because the Greek government has to pay more than 3.5 percent to fund itself on the market. The European taxpayer has at least done something to reduce Greece’s crushing debt load.

But the “contribution” the banks are required to make is a different story. We are told that the financial institutions holding Greek government bonds will have to write off some of the debt. We are told by the bankers’ lobby, the Institute of International Finance, that the reduction in the net present value of their bonds is 21 percent.

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