Europe’s Plan Won’t Cut Greek Debt: Allen, Eichengreen and Evans

This post was written by Philip Lane

Eichengreen and his collaborators delve into the details of the Greek debt plan in this Bloomberg article.

32 Responses to “Europe’s Plan Won’t Cut Greek Debt: Allen, Eichengreen and Evans”

  1. Joseph Ryan Says:

    Congrats to BryanG who I think was first to rumble this one.

    The Eichengreen article confirms what many had suspected, the reported PSI hairrcut of approx 20% on the Greek deal was a scam. He is putting the haircut at less than 2%.

    Even after taking into account that Greece pays back only 80 percent of the original principal in year 30, the present value of debt falls only 1.78 percent under this option. This is a far cry from the 20 percent discount applauded by many analysts. And, to entice bondholder participation, Greece must borrow an additional 26.10 percent of the original face value to purchase the zero-coupon bonds’ principal collateral for the discount security.

    Well, when you take the advice of a fox (Ackerman/Deutsche) on how to stop foxes from attacking the hens, this is what you get.

    And the current events are a direct consequence of the failed deal.

    One question, if I may.
    If the ECB is independent and can of its own volition intervene in a very large way in the markets, why is the ECB prepared to allow economic meltdown rather than do this?
    Surely if the ECB buys Italian or Spanish or bonds of any country that has a fighting chance of survival, then it is not taking massive risk. It s merely providing liquidity and at a potential (say approx 4%) profit, when the bonds get paid.

    Why does it seem that the ECB is toying with the destruction of Europe?

  2. tull mcadoo Says:

    How come they French banks are taking an impairment charge of 21% on their GGBs while RBS took a 50% hit. This does not seem to chime in with the above article.

  3. Yields or Bust Says:


    Despite being an entirely discredited organisation S&P have just affirmed Irelands rating at BBB+ with a stable oulook. They suggest that the Debt/GDP Ratio will top out at 110%.

    Irish 10 year bonds now yielding 9.787% from a recent closing high of 13.782% on 18th July.

    The ECBs market intervention yesterday has obviously had an effect however the rally since 18th July was not entirely ECB driven. Somebody it seems is believing the austerity storyline as the way out of the mess - for how long only time will tell.

  4. Joseph Ryan Says:


    re RBS
    See page 16 (Note 1). It has to do with IFRS reporting standards.

    RBS are taking a 50%, hit to mark the bonds to market vale. They do say there will be a credit of £stg 275m, if the Greek deal goes through.
    It looks like the 9% assumed discount is the main difference between the banks saying the haircut is 21% and Eichengreen saying it is <2%.
    I know little about this area but was always sceptical of the PSI as reported.

  5. tull mcadoo Says:

    Lets leave the RBS issue aside. Barry is saying that the real haircut is 2%. Yet the Eurozone banks thus far have taken a 21% writedown/provision on their Greek Debt maturing between 2011-20. Their is an inconsistency here. Somebody’s numbers are wrong.

    Now back to RBS where they have been even more conservative with a 50% provision.

  6. DOCM Says:

    @ All

    I do not think that the figures are really the issue. The question is who is responsible for what? While Barroso missed a good opportunity to keep his mouth shut, the behaviour of the Bundesbank’s representatives, both present and previous, in breaching the confidentiality of the Governing Council’s deliberations is hardly any better.

    Paul de Grauwe was very good on RTE this morning in explaining the politics of the situation (including the benefit to Germany of being able to borrow at minimum cost) and better than in his FT article - reproduced in today’s IT - as to the situation confronting the ECB.

    The ECB is being placed in an impossible situation. Its largest shareholder - Germany - does not wish it to act in the role of LOLR by buying sovereign bonds and the same shareholder is waltzing around its responsibility to establish an alternative or, at the very least provide the necessary element of political backing and legitimacy to the ECB, a fundamental point adverted to by the WSJ - now unfortunately firmly behind its pay barrier - when it said that the action was a matter for decision by democratically elected politicians, which indeed it is.

    We will see if a confused German political establishment can tough it out over the weekend. There is a change in the background situation in that Germany’s great white hope, that of reducing reliance on what is effectively a tied European domestic market by cosying up to major economies outside Europe, notably China, now seems to be a form of wishful thinking. German industrialists will have a clear awareness of the fact that the hit for Germany post-Lehmans was one of the biggest among the larger economies. Unfortunately, Merkel has allowed a mistaken political narrative to develop in German public opinion - if she has not actively encouraged it - which casts the country as the sacrificial victim of the situation when by any measure it is the main beneficiary.

    She is now deservedly well behind in the opinion polls. Watching your shares go through the floor has an illuminating impact on any voter, of whatever nationality.

  7. hoganmahew Says:

    The ECB does not have the capability of holding back the tide of the bond market. It is not structured that it can deploy unlimited amounts of cash in the way the Fed did.

  8. The Dork of Cork Says:

    I don’t think the ECB can buy gov bonds like a more tradional treasuary / CB relationship.
    I think there’s a misunderstanding of QE .
    What is QE.
    Its excess reserves in the banking system that cannot or will not be lent out.
    The tradional CB holds this stuff and gives the interest income back to the treusary.
    Therefore the private sector is excluded from potential consumption from interest income.
    The QE is the opposite of the 1980 - 2008 period in the US - during that period interest income was used for large scale consumption.
    , now under QE 2 (not QE1) the treusary gains income from interest.
    So if the ECB cannot do this given its structure , what can it do ?
    First of all - the buying of debt on the secondary market and subsequent sterilization does not accomplish much as their base does not increase.
    So what can it do ?
    It can give electronic euro cash to goverments , goverments can then spend this without getting into further debt -
    This will not cause consumer inflation (I think !) - its just a mechanism that provides money into to system so that consumers can pay down private debt.

  9. Joseph Ryan Says:


    The ECB is being placed in an impossible situation. Its largest shareholder - Germany - does not wish it to act in the role of LOLR by buying sovereign bonds..

    What is this about the largest shareholder? We have been reminded ad nauseum that the ECB is independent etc.
    What would the big problem be if the ECB ended up with with two or even three trillion of sovereign bonds, if it resisted buying until say 6%?

    You are correct about the sheer stupidlity of Germany thinking that its future lay in trade with China and framing its attitude to Europe accordingly.
    It goes to show that irrational exuberance is not confined to financial markets or housing bubbles. Well, I imagine many German are looking at the pensions funds and job security this morning (like the rest of the world) and wondering Quo Vadis?

  10. Chris Says:

    - “the sole purpose of the exercise (lastest actions by EU) was to mislead (the general population)”
    Why are so many of the worlds leading academics starting to sound like conspiracy theorists?
    They’re right you now. The elite by in large run the media and the banks and fund policital parties and that is how they get away with it.

  11. DOCM Says:

    @ All

    Incidentally, the Joker in the situation is the pending decision of the German constitutional court on the existing EFSF. Herewith a link which provides a useful background in that it represents a highly critical - justifiably - comment by a German legal expert on its judgement in relation to the Lisbon Treaty. The German court is, of course, not alone among supreme courts in having a misplaced sense of its position in the order of things. It has, effectively, filled the role of the eurosceptic political element evident in every European country but which was not hitherto been respectable in Germany. Now that it has become so, with the FDP stepping into the breach, the court may come up with a judgement more in tune with its proper role.

  12. Joseph Ryan Says:


    I don’t know how many banks have taken a writedown/provision yet.
    The 21% was merely the haircut figure that they ‘reported’ or ’spun’ and were backed up (kind of !) by a most complicated EU press release.

    The Eichengreen article does I think give the reason why its not 21%. As I understand it he is saying that it is a 21% haircut on the new Greek bonds but these are at a higher yield that the old bonds. If one takes the existing Greek bonds at their present yield then the true haircut on the full transaction would be <2%.
    In theory therefore one has a gain of 19% on the old bonds at the moment the swap in done and a loss of 21% on the new bonds.
    The banks have chosen to spin the second figure and ignore the first.

    I could be wrong on all this. Still I would side with Eichengreen rather than the banks.

  13. The Dork of Cork Says:

    The ECB does not have to buy any Euro sovergin debt - it can just give electronic cash to goverments , as sov debt matures they can replace it with cash.The ECBs money is seperate from indivdual sovergin debt.
    Under more tradional CB / treasury relationships the sov debt is in many ways just cash with a interest rate on it.
    But the power dynamics & mechanics are somewhat different between these organistions under the euro system.

  14. Milton Keynes Says:

    As Bryan G has pointed out in a previous thread, the ECB’s motivation is purely political. It is using the crisis to force greater economic integration by rewarding those who roll over and surrender (most notably Ireland) and blackmailing those who don’t (Spain & Italy). It seems so obvious and fundamental, it is amazing that so much of the comment surrounding the crisis fails to pick up on this.

  15. The Dork of Cork Says:

    You make a good point.
    This level of stress withen the system is not in the ECBs interests.

  16. Chris Says:

    Can the EFSF and the IMF rescue Italy and Spain like they have the others?
    This is the most pertanant question at the moment.
    The answer seems to be perhaps they can if Germans etc agree to pay up a substantial sum.
    If they can’t or don’t then what happens?
    Is there another global financial crisis or duoble dip as Goldman Sachs AIG and Bank of America have to pay out on CDS which they thought they never would?

  17. tull mcadoo Says:


    BNP, Soc Gen, Deutsche, and Credit Ag have all taken 21% haircuts on their Greek Sovereign holdings as they reported their earnings. This is not an exhaustive list. Back to the substantive point. BE says the haircut is 2% but the banks are writing down by 21%.


    The actions of the BUBA member(s) on the ECB council is little short of treacherous and they are probably in breach of their fiduciary duties. They are supposed to be independent of their own govt. How would the Germans react if the peripheral council members came out publically in favour of QE.

  18. Bond. Eoin Bond Says:

    @ Joseph

    i think you’re almost there. Its not the current ‘yield’ on the Greek debt that is the issue, its the current ‘coupon’. Average issued coupon (assuming issued at par, which for the most part they were ignoring ‘tap’ issues) is 5.02%. New coupons will be 6%+. So thats an increase on the outstanding debt servicing cost, if we mark back to par. If you discounted the new debt servicing cost back by 9%, this deal/exchange would be fine, but if you discount it back by the origination coupon (5.02%), its not fine. So its not fresh money coming in at 6% replacing existing money at 9%, its new money at 6% replacing old money at 5.02%. I think thats where it all comes from? Anyone else go a view?

  19. Kevin Donoghue Says:

    Perhaps I’m misreading, but my impression is that Allen, Eichengree and Evans are looking at the numbers purely from the Greek viewpoint — how much Greece would have to pay if the recent deal were actually the last word. The bank writedowns tull refers to are presumably just provisions, based on the reasonable assumption that there are more severe haircuts to come.

  20. desmond brennan Says:

    This is no longer a Euro problem. It is one of financial stability, at global level. PIIGS debt is toxic, and is causing grave uncertainty in the real economy. This is a vicious feedback loop, and needs to be broken urgently. Lehman’s was a disorderly default type event and that caused chaos. This is seemingly larger, and more complex. The real economy is in peril, the stockmarkets are badly shook, the moneymarkets a mess.

    The ECB intervening and buying up the debt that just happens to be in the secondary market, won’t address the issue. I’m skeptical if an orderly (partial) default could be achieved for PIIGS this weekend. Also Europe has been speaking in a maddening cacophony over the past few months, so soothing words, nor will not be credible

    The toxic debt requires to be dealt with, and ringfencing it is the answer. An agency needs to intervene, and buy 20-60% of all Euro debt, for all Euro countries. This debt needs to be redenominated as super junior. This action would remove the uncertainty. The smoothest source of the funding, would be money printing.
    Given the global threat to financial stability, other countries and agencies should consider involvement. The ECB, as presently constituted can’t do it….also the Euro is not a currecny in demand. I suspect…suspect that the Fed printing a small few trillion to back it would make more sense. This seems like a good idea to me as the dollar is in ridiculous over demand right now.

    Also, the ridiculous position of the dollar as global peg currency/trade currency needs to be resolved. The balance of payments mess caused by excess dollars is inimical to production. If there’s any way to use this crisis to move towards a basket type SDR as global reserve currency, it should be seized. (apologies for repeating some points from other thread)

  21. Bond. Eoin Bond Says:

    @ Desmond Brennan

    “This is no longer a Euro problem. It is one of financial stability, at global level.”

    Olli Rehn, is that you?


    Co-ordinated policy response from all the major central banks next week?

  22. tull mcadoo Says:


    is there not a touch of if me aunt had etc… about that point. Greece is getting 6% coupons over the long term to replace existing maturing coupons at 5%. It was never going to be able to replace the 5% coupons. Now whether it is 2-20% of reduction is probably moot. That reduces debt/GDP from 170% to either 168% or 150% …it is still in the wrong place.


    yes and now. The EZ banks have provided at 21%-presumably to reflect their estimate of the final haircut. In their view its definitive. RBS has gone a bit further with 50% presumably implying there is more to come. I know who I think is more realistic

  23. The Dork of Cork Says:

    This is a simple problem - money must be provided to pay down private debt - only goverments can provide that money now as large scale credit production is unsustainable but unfortunetly they have a CB that thinks its Martian and not of this world.
    The most important function of money is as a medium of exchange , otherwise commerce & trade breaks down.
    Gold can become a store of value - the Bundesbank has supposedly 3000+ tons of the stuff , how can it lose ?
    Unless of course their Gold is under Manhattan Island or perhaps not there at all !
    The Bundesbank is a post war creation - it has links across the Atlantic………………

  24. Chris Says:

    @Eoin Bond, yes thats it the banks are using the 9% figure and the academics the 5% figure.
    From Greeces point of view the principle may be reduced but the interest rate is higher at 6% to 6.8%.
    In the secondary market on greek bonds are selling for between 50% and 75% of their value. This was not really reflected in bondholders balance sheets. So now these banks have reflected a 20% loss in their balance sheet now on something which is actually worth less according to the secondary markets. In return they get a much safer product which seems to be backed by some sort of collatoral. Seems like a good deal for them to me.

  25. Ceterisparibus Says:

    US creates 117,000 jobs. 88 economists surveyed by Bloomberg had forecast 85,000. So how’s that for forecasting.

  26. grumpy Says:

    That NFP number sets up more open debate about austerity and likely more indecision, tending to austerity among the politicians. More drift.

  27. DOCM Says:

    @ Joseph Ryan

    What I say about the ECB is simply a statement of fact. It does not imply any limitation on the independence of that institution which has been demonstrated time and time again. But all must live in the real world and pushing the envelope of its treaty remit by unrestricted bond purchases, without clear political backing and guarantee support of the largest economy in the EZ, is hardly a viable proposition (an aspect of which Barry Eichengreen - in a radio interview just now - either is unaware or chose to ignore).

    I did not use the characterisation of Germany, or Germans, that you attribute to me nor would I ever (no more than with regard to any other nationality). The point is simply that, if there is a downturn in the global economy, it will be difficult for Germany to offset a fall in consumption of her exports in the EU in third country trade.

    That I consider Merkel a leader who is not up to the job can be gauged from my various contributions. But I am hardly alone in thinking this cf. (especially in relation to the sale of tanks to Saudia Arabia which has not become any less controversial).

  28. Bryan G Says:

    Bond-exchange NPV calculations produce very different results depending on the discount rate used to value both the old and the new debt streams. The Greek case is discussed in more detail here and concludes

    In a nutshell: The IIF has assumed low discount rates on the Greek debt that financial institutions currently own, making it appear more valuable than it really is. And the 9% discount rate applied to the new bonds assures a hefty NPV loss compared to the old bonds.

    i.e. the IIF are assuming that the existing Greek debt is risk-free, and will be paid back in full and on time, and so is overstating the value of the old payment stream. The article continues with:

    Compared to realistic alternatives, the losses are much smaller. Barclays analysts note it would be more consistent to assume a 9% discount rate for the old and new bonds. This produces much lower NPV losses, ranging from 0-19%.

    Other analyses have concluded that the 9% discount rate is too high, as it doesn’t accurately reflect the guaranteed AAA zero-coupon element of the new securities - i.e. that it understates the value of the new payment stream.

    However, taking a step back, the main reason why the PSI increases the debt burden on Greece is the €42bn it must borrow for the zero-coupon collateral. This doesn’t enter into it from the point of view of the banks’ calculations, but of course it does from the point of view of Greece. Thus even if you assume an across-the-board discount of 21% on existing debt being exchanged, the PSI still makes things worse, since the cost of the PSI to Greece is the combined cost of the new payment stream to the banks, and the cost of the payment stream to the EFSF to pay back the money borrowed to buy the collateral.

    The IMF have warned about using the NPV metric by itself when evaluating changes in debt sustainability, due to the wide spectrum of results that can be obtained depending on discount rate selected. They prefer measures that include fiscal indicators, such as the change in the size of the primary surplus needed to stabilize and reduce the debt. I think there is plenty of scope for economists to come up with a metric suitable for broad consumption (e.g. one based on primary surplus) to allow for comparisons between “before” and “after” bailout scenarios - i.e. there’s a real need for a “Truth in Lending Act” for bailouts.

  29. Bryan G Says:

    @DOCM et al.

    The current Euro institutional structure and rulebook is inherently unstable. I see two steady-state scenarios that are internally consistent - one is much greater fiscal, economic and debt management integration (let’s call this the “ECB view”) and the other is a return to much more national control e.g. similar to the control that the UK, Sweden and Denmark have (let’s call this the “UK view”).

    I think the ECB view is internally consistent but has tremendous negative implications for Ireland - partly because of the further loss of sovereignty, and partly because of the “single mandate” to protect the value of the currency at all costs. The latter implies a further redistribution of wealth from workers/taxpayers/citizens to those that already have wealth and capital. There is a reason that the US Congress gave the Fed a dual mandate (initially in 1946, and again more strongly in 1978) since a single mandate leads to the enrichment of one group (the moneyed classes) at the expense of the broader population, and deflationary policies that can result in large-scale unemployment.

    I think the “UK view” is internally consistent but I don’t see a path for Ireland to get there from here.

    Now there’s also a “German view” that basically has a vision of Europe as one big Germany in the middle, surrounded by lots of smaller Germanies on the edge, all exporting high-value hard-to-replicate goods outside the EU. This view is not internally consistent and is incoherent and unworkable. This view will eventually crash and burn, since incoherent and unworkable systems always do. As the pressure increases in the coming weeks the German position will start to fall apart.

  30. DOCM Says:

    @ Brian G

    An analysis that is good but in my opinion too black and white. European economies are very varied and include both high and low tech elements. Italy - northern that is - is a bigger industrial power at this stage than France, if I am not mistaken, and Germany has gone past France as an exporter of agricultural produce. The Netherlands is on a par with them in this sector because of her phenomenal horticultural exports. Spain has very strong industrial base around Barcelona and strong links to Latin America. At the time of enlargement, the economy of the Netherlands was as big as ALL the new entrants combined.

    There is also the phenomenon of Germany as an entrepot i.e. an economy that transforms inputs from elsewhere in Europe (a role played prior to enlargement notably by Austria).

    Given the complementarity of many of the economies, I do not see why a balanced mixed economy need not develop right across Europe. The huge error being made in the major Continental countries other than Germany is their attempt to beat Germany on ground of the latter’s choosing. Nothing illustrates this better than the 30 year language dispute about a European patent. It would be clearly in the interest of Spain and Italy to concede, but they refuse to do so. And the dirigiste policies of France simply have to be abandoned. What is required is a liberalisation of all European economies, of Germany in particular where all kinds of restrictions apply, notably in the distribution sector.

    This opening up to a new policy approach may be coming sooner than we think cf. link to Alphaville that I have posted on the thread just opened by John McHale.

  31. tullmcadoo Says:

    Apologies for being slow but I get it now, I think. The GGBs held by the EZ banks are valued at par even though they trade at half that. Move the discount rate up and you create a write-down.
    The package of the securities that the European Banks hold post the swap are valued based on a discount rate of 9%. If however, Greece recovers credit worthiness the DR falls and the value of the asset rises. PSI moves close to zero. Ingenious & very French.

  32. Joseph Ryan Says:


    One further point if I may.

    The RBS provision is approx €£Stg 750M based on a 50% haricut per IFRS which requires that investments held for sales are valued at market value.

    But they will get a credit of £275M if the Greek deal goes through.
    You don’t have to think too hard about who is being bailed out.
    Not a bad days work, £275M, and you don’t even have to show up. A bit like FAS.
    The ECB is there earning it for you.

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