With things heating up in Greece, Lorenzo Bini Smaghi today outlines his case against debt restructuring in Greece. He argues four points:
First, as I already mentioned, it would not be a way to prevent taxpayers from suffering the consequences of bad investment decisions. In our Monetary Union, given the integration of financial markets and the single monetary policy, the taxpayers of the creditor countries would suffer in any case. According to the Financial Times, for instance, a default on Greece’s debt would cost the German taxpayers alone “at least €40 billion”.
Second, this would be a way to punish patient investors, who are sticking to their investment and have not sold their bonds yet, and are confident that with the adjustment programme the country will get back on its feet. Restructuring would instead reward the investors who exited the market earlier or short-sold the sovereign bond, speculating that they would gain out of a restructuring.
Third, it would destabilise the euro area financial markets by creating incentives for short-term speculative behaviour. Given that markets are forward-looking, they would try to anticipate any difficulty faced by a sovereign by short-selling their positions, thus triggering the crisis. This would discourage investment in the euro area because of its potential volatility and perverse market dynamics.
Finally, such a measure would delay any return to the market by a sovereign, because no market participant would be willing to start reinvesting in the country for a long period if they know that this kind of investment might at some stage be penalised. This would thus discourage private sector involvement and oblige the official sector to increase its financial contribution.
These don’t strike me as very strong points.
On the first point, well yes “taxpayers” in Germany who own Greek bonds will lose out but the bonds are already trading at a huge discount to face value so, for many, the losses have already been taken and the price of the bonds factors in a restructuring.
The second point amounts to saying we should reward people who make wildly inaccurate judgments about the Greek macroeconomic situation, i.e. those who “are confident that with the adjustment programme the country will get back on its feet” should be rewarded. Should those investors who believe in Santa Claus get cheques from the EU and the IMF at Christmas?
The third point that investors would look to sell sovereign bonds of peripheral countries in anticipation of a restructuring appears to ignore that this has already happened. For example, Irish sovereign bond pricing is based on the assumption of a restructuring.
The final point, that a restructuring would delay Greece’s return to the market is debatable. Even if debt ratios stabilised over the next few years, private creditors will still see huge risks. A restructuring that restores sustainability, however, would be more likely to restore access to private bond markets.
If these are the best points the ECB have, you can see why they’re losing the argument.