SELF-SERVING FRENCH RECIPE IS WRONG FARE FOR GREECE / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

July 4, 2011 6:58 pm

Self-serving French recipe is wrong fare for Greece

By Patrick Jenkins

A myopic game of chicken. That is the best description I have heard of the to and fro between the European banks and their governments over how best to restructure Greece’s swollen sovereign debt problem.

European governments, notably Germany, and the eurozone authorities, notably the European Central Bank, have been so at odds that the public sector response to the issue has been laughably slow.


The private sector response – evident in French banks’ proposal – last week to roll over a targeted €30bn ($43bn) of privately owned Greek government debt is laughably self-serving.


And yet, it is the French banks’ idea, in the absence of any credible alternative, that now has momentum.


The French government has already endorsed it and the rumblings from Berlin – and indeed from the German banks – are that it is a good basic blueprint.

French and German financial institutions between them are the biggest holders of Greek sovereign debt, holding about €30bn of a total of €340bn between them. So although the talks to develop the proposal into a credible plan are being organised under the auspices of the Institute of International Finance, it is essentially a Franco-German affair.

On Monday, the initiative encountered a stumbling block when Standard & Poor’s, the credit rating agency, said it would trigger a “selective default” of Greece. The European governments seem to be standing by the French banks’ proposal, suggesting the rating agencies’ concerns could be worked around by tweaking the terms of the final plan.


Tweaking is too good for it. This plan needs to be ripped up and replaced with a wholly new one.


There are four essential components to the French plan. The first – that a chunk of existing Greek debt due to mature over the next three years should be rolled over for 30 years – is the one that grabbed all the headlines and looks very generous on the part of creditors (though if German banks get their way that time frame could be cut to 15 or even 10 years).


But component two overrides any hint of generosity: under the plan the Greek government would be forced to buy insurance in the form of totally trustworthy bonds from an unnamed European issuer (most likely the eurozone safety net, the European financial stability facility).


In essence, that means that for every €100 of debt on which Greece might default, the creditor could recover €40 by seizing the EFSF bonds – a nice backstop where currently none exists.


The third component – the inflated rate of interest of up to 8 per cent on the 30-year rolled-over debt – could be horribly counter-productive. Excessive interest payments, which look particularly unjustified given the insurance mechanism, could conceivably be what tips Greece into collapse.


The final element of the plan relates to the scope of the rollover. Limited to a net 50 per cent of outstanding debt, it would leave the Greek authorities to find the money to either pay back the rest of the maturing bonds, or default – the very thing everyone is trying to avoid.


To make matters trickier still, the IIF says additional buy-backs – potentially funded by privatisation revenues or by rumoured rescue money from sovereign wealth funds or Chinese banks – are a vital part of any solution.


But with the €50bn privatisation programme looking hopelessly optimistic and no sign of any funding from sovereign wealth funds outside Europe, a huge funding gap looks inevitable – potentially triggering a need for yet another eurozone bail-out of Greece.


It is no coincidence that this plan had its roots in the French banks, particularly BNP Paribas – the biggest single holder of Greek sovereign debt outside Greece, with a €5bn exposure – and that it has the support of the French government. France knows that although BNP might have the capital strength to absorb even a total wipeout of its exposure, a blow-up at the big French pensions companies that own another €5bn would be politically combustible. But the holders of this debt, who benefited for years from the high yields it offered, should pay the price now that it is in distress.


A solution conceived by private sector investors will never recommend that. The public sector authorities need to take back the initiative of the restructuring effort and stop playing chicken. Unless bondholders are forced to take the pain, this crisis will just drag on and on.


The French financial industry, particularly BNP, is justly proud that it avoided the woes of the subprime mortgage market blow-up and the broader financial crisis that stemmed from it. But this is their subprime and they should be made to swallow it.


Patrick Jenkins is the FT’s Banking Editor.. 
Copyright The Financial Times Limited 2011.