Greek default risk

Somewhere up around 110%, don\’t you think?

A growing chorus of voices is urging the Greek government to restructure its debt as fears grow that a €110bn bailout has failed to rescue the country from the financial abyss and is forcing ordinary people into an era of futile austerity.

\”It\’s better to have a restructuring now … since the situation is going nowhere,\” said Vasso Papandreou, whose views might be easier to discount were she not head of the Greek parliament\’s economic affairs committee.

Worth pointing out that Greece has been in default on its external debts for fully 50% of its time as an independent country since 1829. Further, that there have been some 800 sovereign defaults over the centuries, from Edward III onwards, to Russia and Argentina at the turn of the last century.

With euro base rates at 1.25%, but Greek bonds at 12.99% (so I\’m told), the market is already pricing in a very high liklihood of some sort of restructuring.

There\’s one more part to this. As Duncan has pointed out, it isn\’t just the interest rate that causes problems. It\’s the maturity profile of the debt that does as well: when do you have to roll over earlier loans?

Now Duncan points to the UK\’s rather long average maturity (over 14 years) as an argument that we\’re safe. Safer, certainly, for it puts what we might call liquidity concerns (ie, that we can\’t roll over maturing debt, because we\’ve not got much of our stock of debt maturing in any one near coming year) somewhat to rest but perhaps not solvency ones.

Greece isn\’t in that situation at all, their maturity profile is much worse. They\’ve got loans that they originally contracted in the heady days when they paid the same interest rate as Germany coming due, loans that they\’re going to have to roll over at these new much higher rates. That\’s what\’s going to kill them, not the current borrowing requirements needing to pay 12%, but the entire stock of €340 billion needing to be rolled over, in coming years, and refinanced at those rates.

And, as I say, their maturity profile is such that it\’s not many years before the whole lot will need refinancing.

Which brings us to a nice point made by Ken Rogoff: that a shortening of the maturity of the debt is a sign of a coming apocalypse. It\’s a simple enough mechanism. As debt burdens rise, it\’s longer interest rates which rise more than shorter term ones. If you\’re thinking about the risk of default before lending then of course the possibility of a default looms larger in the mind when thinking about lending to someone for 30 years rather than 12 months. So the debt issuer, seeing these different interest rates, has a natural tendency to issue shorter term debt….and shorter term debt.

Thus the maturity profile of the stock of debt shortens, more needs to be rolled over in any one year and the issuer becomes ever more exposed to a spike in interest rates. Because an ever greater part of the stock will need to be refinanced at those new, higher rates if they do indeed come about.

Indeed, Rogoff goes on to argue that a shortening maturity is an indicator of likely coming problems.

And at some point, it becomes Ourobouros, the whole problems starts to eat itself. Interest rates rise high enough that only issuance at the short end of the maturity profile is even possible, but this just delays the reckoning until that debt itself needs to be rolled over.

At which point, some sort of default or restructuring is simply inevitable.

Fortunately, we\’ve had those 800 experiences in what to do here. We\’ve even got the infrastructure of the people to deal with it. There\’s the Paris Club for official lenders, the London Club for private sector (note, lenders, not issuers).

I can\’t see any way out of this other than default (and that goes for Ireland and Portugal as well). And while it sounds most odd to be relying on France in a moment of crisis, I really would suggest getting those phone lines humming to those guys in Paris.

Just can\’t see any other way it\’s going to play out.

7 comments on “Greek default risk

  1. I see that a former chief of the Paris Club is none other than a certain Trichet, now boss of the bank that probably holds the most Greek debt.
    Since you’d have to be as blind as a welder’s dog not to have noticed that Greece is going down, it’s ironic that it might pull the ECB with it.
    Of course it’s now just a question of timing. Default when the markets are open, or on a Friday night?
    If I was making the announcement I’d do it on Friday 23rd December, just out of spite. (Greek orthodox Christmas being 7th January.)

  2. Spot on Tim…

    All that’s happening now is the ECB is forcing the PIGS to defer their day of reckoning with stupid loans…

    All to avoid the haircuts the European (i.e. French and German) Banks are going to have to take….

    It’s like watching a modern King Canute…

  3. It’s pretty much a given that the PIGS (or PIIGS if you inlcude Italy) are going to have to default at some point. The UK, French, and Germans have only got so much money to bail them out. But they’re not a huge part of the world economy. Substantial, but not huge.

    What happens when the US defaults? Or devalues, which at least they have the option of. Who can bail them out? (Obvious answer – no one). Given that Social Security reform appears to *still* be off the table, I can’t see them getting into surplus anytime soon. Current estimates are 2035 or so. That scares me a lot more than Greece going broke.

    The ultimate “too big to fail” perhaps?

  4. Ltw: there is no prospect of a US default.

    Even if the US economy fails to run a deficit smaller than GDP growth (which is all really need to ‘balance the budget’ – as long as debt/GDP ratio isn’t rising, it’s all gravy), then at that point devaluing the dollar is not just a zero-cost option, it’s the default (ho ho) action in the absence of government intervention to prop it up.

    The only question – as for the UK – is whether the public finances will recover, or whether the currency will need to be devalued further. But in neither case is default even a possibility. If the UK were in the eurozone, then – although much less likely than PIIGS – it might conceivably be possible.

  5. I was looking at my husband’s work pension fund options over the weekend, and ruled out one that was about 50% long-term government bonds on the basis that I didn’t want to have that much money tied up in long-term government bonds. Even though the fees were a bit lower than the overseas passive equities funds.
    (Of course there were other reasons too, but that was the one that outweighed the lower fees point.)

  6. Pingback: Confirming what many people believe about US debt « Samizdata

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