Since back in December, when Fitch Ratings Inc. slashed its credit rating on Greece's debt to below investment grade for the first time in 10 years, there's been a mind-numbing flood of media coverage of that European country's debt crisis.
And yet, despite high-volume of high-level media coverage, none of the stories have picked up on a very basic - yet very key - fact...
The bailout being developed is as much for Germany as it is for Greece.
Let me explain ...
Moody's Corp. (NYSE: MCO) yesterday (Thursday) cut Greece's debt rating one notch, from A2 to A3, and said further downgrades are likely - this after The European Union's (EU) statistical authority cast fresh doubt on the accuracy of Greece's financial reports and said the country's 2009 budget deficit was larger than originally reported.
In its semiannual report on EU debt and deficit, Eurostat said Greece's 2009 budget deficit was $43 billion (32.3 billion euros), or 13.6% of its gross domestic product (GDP). However, the agency noted that it still doesn't have confidence in the new figure, which it said could actually be above 14%. Greece had estimated the deficit at 12.7%.
It may be just a matter of days before Greece asks for a bailout, given these fresh developments.
European governments have offered Greece a rescue package worth up to $45 billion. Most of the funds, which would trigger only upon Greece's request for help, would be in the form of loans with below-market interest rates. As a start, Greece would be able to borrow for three years at around 5%, which is sharply below the 6.9% they are paying now for their sovereign debt. Another $15 billion in loans and assistance would come from the International Monetary Fund (IMF).
It's nice that they came up with something, but this package is a joke. It's far less than Greece would need in the event of a genuine default by at least 3-times, but the European elite wants to make it look as if they are doing something.
This announcement in a videoconference last Sunday wasn't much different than what we already knew from a March 25 statement, but finance ministers contended that the latest plan has more substance than prior assurances. The key difference is that this time, Germany has dropped its demand that Greece pay market rates for the loans.
While the backup plan appears more solid, the big question remains whether Greece will ask for it to be triggered. Since the market is now charging Greece two percentage points more than the Eurozone is offering, it would seem normal for Athens politicians to take the deal immediately. Yet their pride will likely delay the decision, possibly until it's too late.
Here's why: There is still a big question as to whether the public in Germany and France are willing to let these guarantees be made by their leaders. Germany contributes about a third of all Eurozone capital, so it has the most to lose if Greece should default on these loans. The German parliament must approve the deal, so there are many political and legal hurdles that remain. In short, it's a "non-deal deal" in that there are strings attached that could be pulled to unravel it if Greece comes calling.
The strangeness of the deal was revealed in an interview that Greek Prime Minister George Papandreou reportedly gave to the To Vima newspaper. He is said to have commented that the loan mechanism represents a "gun on the table" that can be turned against fund managers who have been short-selling Greek debt and hastening its decline.
If Papandreou was accurately quoted, it does not exactly reveal an atmosphere of love and good will. What Greece needs to do is reduce its spending in the face of massive public distaste and distrust. The next nationwide strike to protest required cuts is expected next week. The market's reaction to that anger will be a big test.
So what's really going on?
I encourage you to see this latest news not as a rescue for Greece, but as a rescue for Greek debt holders worldwide. Greece is not going to disappear as a country no matter what happens. But if a default is declared, it's the debt holders that are hurt. So all of this maneuvering must be seen in the same context as the bank bailouts in the United States: much more vital for ex-buyers than ex-sellers.
Make no mistake: This is precisely why I say that this would be a bailout of Germany, not Greece.
Argentina is always cited as an example of a country that suffered tremendous pain in the wake of a default. And in a sense it did; Buenos Aires has been shut out of global capital markets for a decade since it defaulted on $82 billion in sovereign debt in December 2001. But guess what? Argentina still exists, and life goes on. It's foreign debt holders who lost the most.
Last week, a column in The Economist asked how much pain might actually occur if Greece were to default. In theory, it should be as costly as it was to Argentina but that has not been the case historically, for the most part.
The Economist reported on an IMF study that counted 257 sovereign defaults from 1824 to 2004. There were 74 from 1981 to 1990 alone. Most suffered far less than Argentina, as the majority were able to reenter international capital markets once a credit restructuring was complete -- much like a bankrupt company in the United States can be reborn in months after debts are extinguished.
The IMF data showed that the only lasting effect was a big four percentage-point increase in bond spreads in the first year, and 2.5 percentage points in the second year. The study showed that spreads were largely unaffected after that.
So while the potential for a Greek default has been described as the end of the world for Europe, it really might not even be the end of the world for Greece. If this is true, then it's the angry credit holders - who should have accepted risk in making their decision to invest there - that are making the most fuss.
The bottom line: A case can be made for the notion that all the concern over Greek debt is a ruse manufactured to stampede governments into bailing out private investors. In this context, it's easy to see that the deal will probably be done on some level. But if it's not, don't except Armageddon. Expect an orderly unwinding that will be painful to some investors but probably not the global financial system, as interconnected as it may be.
News and Related Story Links:
Greek Debt Crisis Timeline.
- International Monetary Fund:
Official Web Site.
- Money Morning:
New $61 Billion Aid Package Is No Cure For Greece's Long Term Ills
- Money Morning:
Beware of Eurozone Plans for Greek Debt Bailout
- Money Morning:
Credit Default Swaps Strike Again - This Time Driving Greece to the Brink of Default