Debt and divisions in the eurozone

ECB and Germany at odds over debt restructuring.

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The markets react badly, history shows, when politicians air their disagreements in public. Keep discord behind closed doors, exude a sense of calm, and the markets generally stay quiet. But those in charge of dictating policy in the eurozone have shown that they just cannot help themselves.

The disagreements are there for all to see, as Greece teeters once more on the brink. Of late, the loudest difference of opinion sees Jean-Claude Trichet and the European Central Bank (ECB) pitted against Wolfgang Schäuble, Germany’s finance minister, and the rest of the German government. They are at loggerheads, in public, over the prospect of Greek debt restructuring.

The gloves are well and truly off. Eurozone finance ministers met on Tuesday (14 June), but agreement on the next course of action remains remote. They gather again next Monday (20 June), as they struggle to come up with some kind of deal before the European Council on 23-24 June.

This time last year, they were hoping that the €110 billion rescue package that the EU agreed to for Greece would draw a line under the worst of the crisis. Later, when they backed assistance for Ireland and Portugal, they announced that contagion had been successfully isolated. ‘Ring-fenced’ was the word they used at the time. Then, as if words spoke louder than actions, EU leaders put out a declaration that they would do “whatever it takes” to save the euro. Today, there is frank disagreement over defining just what that ‘whatever’ comprises.

So what now? Some 12 months after Greece’s first crisis, with the country needing another estimated €85bn, the real discord is coming to the surface, crystallised in this very public difference of opinion between Frankfurt and Berlin.

In one corner, the ECB has come out strongly against any forced restructuring of the type favoured by the German government, considering it tantamount to default. Restructuring would make Greek bonds ineligible as collateral at the ECB, and that would raise the risk of a collapse of Greece’s banks, jeopardising the health of the entire European banking sector. After last Thursday’s meeting of the ECB governing council, Trichet firmly restated his opposition to Germany’s proposal. His likely successor, Mario Draghi, warned against “a chain of contagion” when he appeared before the European Parliament on Tuesday. Other senior ECB figures agree. French central-bank governor Christian Noyer said there was a “dangerous illusion” that debt restructuring could make it easier for Greece to make budget adjustments.

Sharing the cost

In the other corner, opposing forces are led by Germany’s government, especially Schäuble, who last week called for a seven-year extension to Greek bond maturities. Several countries in northern Europe believe that forcing private creditors to share the cost of rescuing Greece is the only way of making the idea palatable to an increasingly sceptical public.

Fact File

OPTIONS FOR GREECE

Germany wants to persuade existing holders of Greek debt to exchange their debt for new bonds that would mature only after seven years. If all existing bondholders took part, it would mean that additional international loans might not be necessary, or at least they would be much smaller.

However, credit-rating agencies have indicated that they would consider this to be a default. They say that in order to obtain a sufficiently high level of participation, the process could not be seen as voluntary. Critics say that this would risk spreading contagion to the rest of the eurozone.

Private creditors could be persuaded to agree to a voluntary rolling over of bonds – a course of action favoured by the European Commission, the European Central Bank and France. Banks would be asked to exchange their existing Greek bonds only when they mature and with new bonds that mature at a later date. The Commission calls this a ‘Vienna initiative’ as it would be similar to a pledge made by banks in 2008 to roll over debt when the crisis affected countries in eastern Europe. Opponents say that this would achieve nothing more than postponing Greece’s problems.

The thinking goes that if all bondholders took part, it would relieve taxpayers from eurozone member states of the burden of providing further bail-out loans. A possible compromise, favoured by the European Commission and a group of countries including France, would be to allow a voluntary ‘rolling over’ of bonds when they mature, to encourage as many creditors as possible to take part.

But deep divisions remain. “From a purely financial market-management standpoint, it makes no sense to air all these differences in public,” says Nicolas Véron, of Bruegel, a Brussels-based think-tank. “But from a more political viewpoint, it’s natural. It’s a collision between the logic of financial communication and the logic of political decision-making.”

Nevertheless, the consequences of such actions could be far-reaching. Through talking about forced restructuring, eurozone policymakers have placed themselves in the worst possible situation, says Sony Kapoor of Re-define, another Brussels-based think-tank. “There’s a lot of talk about restructuring, a lot of noise, but then they don’t actually do it,” he says. “So you get all the downsides from restructuring without any of the upsides. On every single measure we have been paying the price of a restructuring without having resolved the situation,” he says.

“Greece is not better off, the contributor countries are not better off, and, most importantly, Europe is not better off.”

As the negotiations continue into next week the deadlock is still a long way from being broken. “It is still hard to see how the ECB and the pack led by the German government can find a truce,” says Carsten Brzeski, a senior economist at ING.

And he questions whether a voluntary debt roll-over scheme would be a success. “A voluntary roll-over scheme at current market prices would not do a lot to lower Greek debt but would probably rather, again, buy time.”

Buying time brings its problems, particularly if that time is wasted. But, says Véron, perhaps because of the nature of politics, this public muddling through is inevitable. “There is a need for maturation of the European discussion on the euro,” he says. “We are at a spectacularly different point in the discussion than we were a year ago. You could argue that in another 12 months it will be different again. It does make sense for the terms of the debate to evolve.”

The question remains however, whether the markets will wait for the politicians to catch up.