Why Greece is the new Lehman Bros
IT is a tale of two economies and two very different responses to catastrophe. Last week, the Icelandic government borrowed $1bn on the bond markets, paying only just over 3 per cent interest. It is an astonishing recovery for a country that just two years ago was written off as a bankrupt, discredited pariah, its banks the poster-boys of all that can go wrong when a financial empire is built on leverage but little else. The Icelandics couldn’t afford to bail out their bondholders – so they put their taxpayers first, only guaranteed the deposits of their own citizens and allowed everything else to go bust in 2008. It was painful – especially for foreign customers of their banks, including in the UK – and a managed solution would have been better but in the end it has worked for Iceland. Sometimes, it makes sense to give up and move on.
Contrast that to the Eurozone, which adopted a very different, head in the sand approach to its problems. Several countries are in trouble, government debt is the new sub-prime and Greece looks like it could be the Lehman of nation-states, its default triggering a freeze in the markets, a domino-style collapse of other countries and a severe economic fallout, including for the UK.
The Greek problem is different to Iceland’s or even Ireland’s: it is entirely about public sector debt, which is rocketing at a time when the economy is shrinking. There is no real hope of Greece ever being able to repay what it owes so the real strategy being pursued by the EU is to try and delay the inevitable as long as possible to allow the European financial system to build up reserves before the unavoidable, crippling write-offs.
As Investec points out, the authorities’ aim is for any bailout to involve the private sector; for the rates payable by Greece to be not so high as to force it into insolvency; that the terms do not result in a “credit event” or a default being declared such that, for example, ratings agencies are happy that there has been no coercion behind the involvement of investors buying rolled over bonds. The absence of a technical credit event would also avoid triggering credit default swaps, the insurance-style contracts that pay out in the event of a default (and that during the previous crisis infamously destroyed AIG, which hadn’t bothered to put enough money aside to pay out on its policies).
A full Icelandic solution – a unilateral, non-negotiated default a la Lehman – would be a disaster. The markets would implode yet again, a development which would badly affect London. But cajoling the IMF into handing over another tranche of bailout cash by promising (rather than actually delivering) austerity – Athens’ strategy – will merely buy time (and also cost UK taxpayers a fortune). It would allow Athens to meet July’s coupon and August’s redemption payments but would have no structural effect. What the Eurozone finance ministers should really be talking about now is how to structure an orderly, partial Greek default, combined with its exit from the euro. If a credible, well-managed solution were put into place, it may still be possible to avoid or at least mitigate the impact of contagion to other weak nations. Merely delaying the inevitable – and eventually ending up with an even larger collapse involving several countries – will go down as a historic blunder and prove that nobody ever learns anything from economic crises.
allister.heath@cityam.com
Follow me on Twitter: @allisterheath