Volunteers wanted: Greece’s creditors would all have to take a massive hit to right its finances







A CATCHY new phrase has been added to the Orwellian lexicon of Euro-speak, where terms such as “stability and growth” actually mean the opposite. This is “private-sector involvement” (PSI), which is code for imposing losses on Greece’s private creditors.

The International Monetary Fund’s most recent review of the Greek economy, in December, gives an indication of the scale of the pain that these creditors need to take. Even if almost all of Greece’s private creditors agreed to write off half of what they are owed, its debt would still be about 120% of GDP by 2020. More likely, participation in any write-off would be lower than that, leaving debt above 145% of GDP in 2020. That implies another debt restructuring would be needed after this one. And since Greece’s economic news has been worse than expected of late, even these numbers are optimistic.

Talks between Greece and its private creditors were still under way when The Economist went to press, but the risks of a disorderly default are mounting. Europe’s earlier refusal to countenance default gave some lucky bondholders a year in which they could get repaid in full with loans granted by official creditors. The European Central Bank (ECB) is now thought to be Greece’s biggest bondholder.

Since official creditors are excluded from PSI, the remaining private creditors must suffer ever greater losses. Fund managers involved in the talks say that the reduction in the net present value of the bonds may be much higher than that suggested by a 50% reduction in their face value: the true figure could be closer to 70%.

Losses of that scale do not sit well with anyone. Only 70-80% of bondholders were willing to participate in an earlier and much more generous “voluntary” exchange that was agreed upon in July and later abandoned. The odds against a widespread voluntary exchange have also worsened because hedge funds have bought Greek debt from European banks in recent months. These funds are less susceptible to pressure to accept an unfavourable deal than banks are.

For recalcitrant bondholders, resisting a deal can pay off in two possible ways. First, if Greece continues with a “voluntary” deal that allows 30% or more of bondholders to reject the exchange, then holdouts can get repaid in full for bonds they bought at a huge discount. Second, if Greece unilaterally imposes losses, bondholders who have bought credit-default swaps (CDSs), a form of insurance against default, would get paid.

The prospect of triggering CDSs spooks many. There are some large headline numbers involved: contracts covering $71 billion in Greek government bonds have been written. Yet most of those who have sold insurance also hold offsetting contracts, leaving a net exposure of just $3 billion. That seems manageable, even if risk tends to pop up where least expected. A Greek default would also risk contagion: the IMF is trying to raise up to another $500 billion in lending firepower to cushion against euro-zone woes.

Bondholders without CDS protection could also have more to gain from a default than a “voluntary” deal since a coercive one might have to include bonds held by the ECB to be legally enforceable. Including the ECB’s bonds would spread the pain more widely. It would also make a meaningful difference to Greece’s debt burden. For PSI to work, it may need to involve the public sector, too.

The Economist, http://www.economist.com