AS GREEK BOND RATES SOAR, THE SPECTER OF BANKRUPCY LOOMS / THE NEW YORK TIMES ( VERY HIGHLY RECOMMENDED READING )

April 8, 2010

As Greek Bond Rates Soar, the Specter of Bankruptcy Looms

By LANDON THOMAS, Jr.

LONDON — As interest rates on Greek debt spiral upward again, the question facing Europe is no longer whether Athens has the political will to cut spending and raise taxes to curb its gaping budget deficit, but whether Greece will run out of money before it gets the chance to do so.

With the rate on 10-year Greek bonds reaching as high as 7.5 percent on Thursday, up from 6.5 just three days ago, the cost of insuring against a Greek default hit a record high.

The message from the market could not be clearer: artfully worded communiqués from Brussels will no longer suffice. To avoid bankruptcy, analysts said, Greece needs a bailout from Europe, and fast.

“This is no longer about liquidity — it’s a solvency issue,” said Stephen Jen, a former economist at the International Monetary Fund who is now a strategist at BlueGold Capital Management in London.

But with European officials consumed with a debate over whether loans to Greece should be offered at rates consistent with a typical I.M.F. bailout or punitive ones closer to current market levels, the risk is that while Brussels fiddles, Greece is burning.

At a press conference on Thursday, Jean-Claude Trichet, the president of the European Central Bank, sought to break the fever in the markets by saying that the aid program proposed by the International Monetary Fund and the European Union was a “very, very serious commitment.”

The statement helped bring yields on 10-year Greek government bonds down from their peak for the day, to 7.35 percent, but it was not enough to turn around the mood of pessimism that contributed to a further fall in both Greek and European stocks.

“Time is running out,” said a senior official in the Greek government who spoke only on condition of anonymity because of the sensitivity of the issue. “The market is testing Europe’s resolve.”

To a large extent this latest bout of Euro-stasis is a function of Germany’s view that it is not the market contagion from the Greek drama that presents the greatest risk to Europe. Instead, Berlin is far more worried, as Mr. Jen puts it, about the supposed “contagion of bad behavior” in other countries like Portugal and Spain that might follow if Greece were to become the beneficiary of a bailout on relatively generous terms.

“This should be easy to do — Greece is only 3 percent of Europe’s G.D.P.,” said Paul De Grauwe, an economist based in Brussels who advises the president of the European Commission, José Manuel Barroso. “But this is no longer a financial issue. It is about politics and nationalism and it is a real setback for those who believed in a united Europe.”

There are unmistakable signs that individuals and corporations are withdrawing funds from Greek banks, although the sums involved do not yet constitute a bank run.

Still, weakened Greek banks, increasingly shut out of the capital markets, have become largely dependent on the European Central Bank and have turned to the Greek government to release more money from a previously established rescue fund.

The Greek government is coming close to giving up on private investors as well. While Athens said it would go ahead with its short-term borrowing auctions this week, the planned fund-raising trip this month by Greece’s finance minister, George Papaconstantinou, to tap Wall Street investors is unlikely to happen as long as Greek borrowing costs remain so high, said a person who was briefed on his plans.

Greece’s hope is that it will be able to borrow as much as 30 billion euros ($40 billion) from Europe and the I.M.F. at a rate of about 4 percent or so, which is consistent with the terms offered by the fund to other indebted countries.

Such a view, however, presupposes that the I.M.F. is the lead actor in the rescue, as it was in countries like Hungary and Latvia that are not in the euro zone. In all the vagueness of the European Union’s agreement with the I.M.F. on Greece, the one point of clarity was that Brussels rather the fund should dictate terms, even if a team of I.M.F. experts was already on the ground in Athens advising the government.

As a result, European officials, pushed hard on this point by Germany, are now saying that Greece must not receive the carrot of concessional interest rates available to those who agree to accept the stick of an I.M.F.-style austerity package.

Greece’s interest payments on its net debt, as a percentage of its gross domestic product, are already the highest among developed nations, according to recent research by Deutsche Bank. And as the economy withers further as spending cuts and tax increases begin to bite, its ability to generate the needed revenues to pay these sums decreases.

“If you look at Greece’s G.D.P. potential and its borrowing costs,” Mr. Jen said, “there is a gigantic gap.”

The sharp spike in rates has spurred increased talk of some form a debt restructuring. Under such a scenario, analysts said, holders of Greek debt could perhaps be forced to accept a loss of 20 percent or more on their bonds. That would be similar to what happened after Argentina defaulted on $93 billion in debt in 2001. Like Argentina, Greece has suffered from a fixed currency, fiscal deficits and a growing lack of industrial competitiveness.

Still it seems unlikely that Europe — which via German and French banks owns over 100 billion euros in Greek bonds — could countenance such a solution.

“If you do a restructuring,” said Yannis Stournaras, an economist and adviser to previous socialist governments, “people would not lend any further money to Greece,” he said. “That would be a huge mistake,” he added. “Greece has the mechanism — it just has to ask for the money.”