LITTLE CHARM IN BERLIN´S DEBT OFFENSIVE / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

July 7, 2011 5:30 pm

Little charm in Berlin debt offensive

By Peter Spiegel in Brussels

Anyone who thought the controversial decision by Moody’s to downgrade Portuguese debt this week was about Portugal missed the point. It was really about Germany.


Sure, the decision featured warnings that Lisbon had a tough row to hoe in order to meet debt and deficit targets in its €78bn ($109bn) bail-out programme.


But the real message from Moody’s is the same one being delivered to European capitals by the financial markets: if Germany is going to insist that private bondholders bear a chunk of the pain for a new Greek bail-out, we must assume that private bondholders are going to have to pay up for other bail-outs, too.


So, dear investor, abandon ye peripherals while ye may.


This is not the first time the German obsession with sticking it to holders of peripheral bonds has spooked the markets and threatened to destabilise the global recovery.


During last year’s fight over the original Greek bail-out, Angela Merkel, German chancellor, threatened an “orderly insolvency” process for Athens – financial jargon for leaving bondholders short – only to see investors flee Greek bonds and, a week later, forcing an eye-popping €110bn rescue.


Then, last autumn, Ms Merkel’s insistence that a new €500bn eurozone bail-out system include provisions for bondholder “haircuts” led to a run on Irish debt that forced Dublin into a bail-out.


Now Berlin’s edict that Greek bondholders must shoulder as much as €30bn of the €115bn Athens will need in a new three-year bail-out has contributed to weeks of chaos, forcing repeated downgrades of Greek debt and driving up borrowing costs for the likes of Spain and Italy.


This week the German position stoked even more panic. After agreeing to a more-tame (but still disruptive) plan to simply ask bondholders to roll over Greek debt that comes due in the next three years into longer-maturing bonds, Berlin has reversed itself once again, saying that a more coercive plan to push investors to swap their holdings for new Greek bonds is back on the table.


No wonder the normally staid International Monetary Fund has called the German-led debate “unproductive”. On principle, of course, it is hard to argue with Ms Merkel. In a perfect world, investors in Greek, Portuguese and Irish bonds would feel the consequences of their bad bets, just like investors in Las Vegas real estate or Lehman Brothers stock have seen their own positions wiped out.


It is at best unseemly – and at worst immoral – to ask taxpayers in Germany, the Netherlands and Finland to loan their hard-earned wages to heavily indebted peripheral governments so they can make those wrong-headed private bondholders whole.


But policymakers must live in the world as it is, not as they want it to be. And the reality is that the only way the eurozone can emerge from the current crisis is for Greece, Ireland and Portugal to be weaned off the bail-out teat and sent back into the private credit markets.


All three bail-outs envisage this happening relatively quickly. Tragically for Greece, the European Union and the IMF badly underestimated how hard it would be for Athens to return to the bond market, forcing the crisis and the need for a second bail-out.


Although the programmes for Portugal and Ireland have more modest goals for their return to the credit markets, they are not insignificant: Lisbon is expected to raise €16bn in long-term financing from the bond market in the final 18 months of its bail-out, while Dublin must raise €17.4bn in short- and long-term loans over the next two years.


If any of these countries is to have any hope of luring private investors back so that their government operations can be funded in the open market rather than by EU-IMF bail-out loans, eurozone governments need to make it more attractive – not less attractive – for bond traders to return to peripheral bonds.


Telling those same investors that Europe now has a policy of forcing them to take unexpected losses is not anyone’s idea of a charm offensive. As Moody’s rightfully noted, it is, in fact, a good motive for investors to find somewhere safer to park their money – perhaps never to return.



Copyright The Financial Times Limited 2011.