Nothing illustrates better the political crosscurrents, special interests, and shortsighted economics now at play in Europe than the debate over the restructuring of Greece’s sovereign debt. Germany insists on a deep restructuring – at least a 50% “haircut” for bondholders – whereas the European Central Bank insists that any debt restructuring must be voluntary.
In the old days – think of the 1980’s Latin American debt crisis – one could get creditors, mostly large banks, in a small room, and hammer out a deal, aided by some cajoling, or even arm-twisting, by governments and regulators eager for things to go smoothly. But, with the advent of debt securitization, creditors have become far more numerous, and include hedge funds and other investors over whom regulators and governments have little sway.
Moreover, “innovation” in financial markets has made it possible for securities owners to be insured, meaning that they have a seat at the table, but no “skin in the game.” They do have interests: they want to collect on their insurance, and that means that the restructuring must be a “credit event” – tantamount to a default. The ECB’s insistence on “voluntary” restructuring – that is, avoidance of a credit event – has placed the two sides at loggerheads. The irony is that the regulators have allowed the creation of this dysfunctional system.
The ECB’s stance is peculiar. One would have hoped that the banks might have managed the default risk on the bonds in their portfolios by buying insurance. And, if they bought insurance, a regulator concerned with systemic stability would want to be sure that the insurer pays in the event of a loss. But the ECB wants the banks to suffer a 50% loss on their bond holdings, without insurance “benefits” having to be paid.