What to do about Greece

Economist
January 28, 2012

Greece, progenitor of the euro zone’s debt drama, is back at centre-stage. The reason is a battle between the Greek government, its European and IMF rescuers, and the holders of Greek bonds over the terms of a “voluntary” reduction in its private debts. Greece’s economy is in far worse shape than when the outlines of a deal were put together last October, so there is a bigger financial hole to plug. Germany and other rescuers don’t want to offer more money, not least because Greece’s politicians have broken so many of the promises they made to reform. Bondholders don’t want to take a bigger hit.

If no deal is in place by March 20th, when a big bond payment is due, Greece will be pushed into a chaotic default, which would increase the risk that the country is forced out of the euro. That is a frightening prospect. The ensuing chaos and contagion could fell the single currency, not least because Europe’s governments have made little progress on building a “firewall” around countries like Italy and Spain.

What is the best way out of this mess? Step one is to force private bondholders to take more losses. They have been treated with kid gloves so far because European governments insist the debt deal must be voluntary, thanks in part to a misplaced fear of triggering credit-default swaps. That must change. Discard the veneer of voluntarism and Greece can be tougher on its creditors. It should pass a law that retroactively introduces collective-action clauses into all domestic-debt contracts (making it easier to impose debt deals on recalcitrant bondholders). If it does this now there is still, just, enough time to organise a big, coercive, but orderly, restructuring of Greek bonds by March 20th.

That is the route this newspaper has long advocated. A year ago it would have gone a long way towards solving Greece’s problems. Unfortunately, today it is no longer enough. The economy is in such a state, with slumping output and a still-gaping budget deficit, that there is no realistic prospect of reducing its debts to a sustainable level by hitting private bondholders alone. Debts owed to official bodies—from the bonds held by the European Central Bank to the loans from euro-zone governments—will at some point need to be reduced too.

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