Greece Concerns Color EU Summit

 | Jan 30, 2012 | 5:00 PM EST  | Comments
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Even though Greece is not officially on the docket for today's European Union (EU) summit, it is on the minds of both investors and policymakers. Two years into the crisis, no deal has yet been conclusively reached to reduce its debt burden to sustainable levels, reflecting an impasse between Greece and boldholders.

Meanwhile, EU and other government officials, particularly in Germany, are frustrated by Greece's slow (or no?) significant progress to make necessary reforms to its budget or economy, such as those pertaining to labor laws and tax collection structures.

Both bondholders' reluctance to accept a more significant loss on their holdings and Germany's apparent signal that it may withhold the next tranche of aid if Greece does not adopt necessary reforms could possibly push the country into default when its next debt payment is due on March 20.

So far, though, there has been some indication that these issues can be resolved by then; hence, the market's relatively muted reaction to the situation. But here's a cynical, question: Are some investors who simultaneously hold Greek debt and credit default swaps (CDS) actually desiring a more disorderly default in order for them to receive payment on them? Right now, under the terms that bondholders' accepting the 50% debt reduction is "voluntary," swap payments might not be triggered. However, I wonder whether some bondholders might perversely want the country to default, even if it is disorderly and leads to an even greater loss on the bonds, if it would then qualify to result in a profitable payoff of those investor's CDS, more than offsetting the loss on the bonds? Perhaps this is why those investors seem to be reluctant to come to a definitive agreement to bear an even greater loss on their bond holdings in the negotiation process between Greece and its bondholders.

Then there is Germany. Recalling the popular fable, the frugal, diligent, hard-working ant is reluctant to simply hand over aid to its southern grasshopper neighbor that seemingly can't adopt necessary, yet painful, reforms to suffer the consequences of its past fiscal misdeeds. Germany can arguably afford to come to Greece's aid, but its resistance seems to be a matter of principal; deviation from which is difficult for German leaders to accept and even more challenging to sell to their voting constituents.

This impasse needs to be addressed, and soon. However, when asked by The Wall Street Journal whether the eurozone would grant or withhold the second bailout package for the country since 2010, Wolfgang Schäuble said that he expected it to be in excess of 130 billion euro ($172 billion) and that the decision is for Greece to make whether it will reform its economy and government policies, including such things as tax collection and labor markets, in particular. If not, Germany will withhold aid for the country, which may well send the country into default. In the interview with the Journal, Schäuble said that Europe is "prepared to support Greece" with the new loan package, but he warned: "Unless Greece implements the necessary decisions and doesn't just announce them ... there's no amount of money that can solve the problem."

I am cautiously optimistic that Greece can reach an agreement with its creditors, but acknowledge the risk that some bondholders at the negotiation table just might have a perverse incentive for Greece to default. Under the general guise of "something is better than nothing," I would venture to say that a perhaps rational group of investors with no competing motives or perverse incentives would have already reached a deal by now, given the obvious inability for the country to pay in full.

The more challenging part is enacting the structural reforms that Germany wants. As Schäuble alluded to, talk is easier than action. The Greek people are reluctant to endure any more pain, though further efforts may be necessary to result in lasting, long term change and economic growth at some point down the road. Laws take time to be debated and passed, but cultural influences, such as employment practices or attitudes toward paying (or not paying, as the case may be) taxes requires a change in the mindset of the people. Even more difficult for Greeks to stomach is that Germany believes that it, or the EU, should have oversight of Greece's budget, which would effectively cede some Greek sovereignty to its northern neighbor or the EU.

Still, if Greece can take meaningful steps toward convincing Germany that it is changing its economic structure, then perhaps Germany will relax its principles in favor of pragmatism to allow for another tranche of aid to ensure Greece can avoid a messy default. Of course, Schäuble also said it is "too early to sound the all-clear."

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