Unpleasant Greek options

By R.A. | WASHINGTON

TODAY has been a nasty day for markets, those in Europe especially. Equities are off. The euro is falling against the dollar. And yields on the debt of euro-zone periphery governments are rising to new heights. The yield on 3-month Greek securities is now over 12%. Markets want nothing to do with Greece if they can help it.

European yields have spiked many times before, and each time European leaders have responded with a new bail-out package or other reassurances to prevent Greek panic from fueling a broader contagion. (Over the whole of the crisis, of course, this strategy has been a bit of a disappointment.) So where's this go-round's intervention? Well the trouble at the moment is that Europe's leaders can't agree on one.

It has become clear that euro-zone governments will be reluctant to contribute more support to Greece unless its private creditors also take a hit. But there is significant disagreement over how to achieve this haircut. All the plans currently under discussion are nominally "voluntary", but voluntary means different things to different people. The German plan is to convene a meeting of Greece's major private bondholders in order to "convince" them to participate in a debt exchange, in which current obligations are traded for new ones with extended maturities. The upside to this plan is that the more coercive aspects of it are likely to make for a high level of creditor participation, and a correspondingly larger benefit to Greece.

The downside, according to critics like the European Central Bank, is that those coercive aspects would practically guarantee that the haircut would be judged a default event, and that, the ECB has maintained, is unacceptably riskly. Their preferred policy is a more honestly voluntary commitment among bondholders to rollover maturing Greek securities into new issues. But many creditors are sure to balk at the request to lend more to the Greek government. If take-up is low, then so too is the impact on Greek insolvency. And there's still a risk that the plan could run afoul of rating agencies, earning the official default stamp.

Other troubles complicate the picture. Markets are increasingly worried about bank exposure to Greece. Moody's announced today that it would review the status of several French banks based on their holdings of Greek sovereign debt. The German plan, with its greater hit to creditors, could force European governments to pony up €20 billion or so in funds for bank recapitalisation. And if the ECB responds to a creditor haircut by refusing to take Greek government debt as collateral for new loans, and it has threatened to do so, then euro-zone governments may have to cough up funds to replace the debt now being held for that purpose: totalling perhaps €70 billion. Why would the ECB force governments to do this? Maybe because it thinks it will accelerate fiscal integration. Or maybe because it worries that in the event of a default euro-zone governments will be stuck financing Greek borrowing indefinitely.

Oh, and violent protests are wracking Athens today, as Greek demonstrators rebel against enforced austerity.

It's not an insoluble set of problems. But given the euro-zone's institutional weaknesses, it's not a walk in the park, either.