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In the latest phase of its financial melodrama, Greece successfully placed a €5 billion 10-year government bond in the financial markets on Thursday (March 4). The bond issue was heavily oversubscribed, but it still produced a high yield of approximately 6.3 percent (or approximately 300 basis points above the benchmark risk-free mid-swaps rate, reflecting the market's demand for a risk premium).
In many ways, this Greek return to the financial markets represents a huge success for the government and at least a temporary sign of approval from bond market vigilantes for its recently announced additional austerity measures. Ironically, however, this very success means that the leverage of the Greek government over its eurozone partners in the game of chicken related to possible financial assistance to Athens has been greatly reduced.
Frequent invocations by eurozone leaders of "European solidarity" notwithstanding, the principal hard leverage Greece has had against the French and German governments in particular has been the exposure to a Greek default of French and German banks, which own the largest amounts [csv] of Greek foreign debt. This has been a kind of North Korean style bargaining power1—support us or we will collapse and in the process really hurt you, too. Now the successful private bond placing at least temporarily reduces the risk of a Greek bond default and thereby also reduces the risks to French and German banks.
Score this episode as an at least temporary victory for Greece's eurozone partners who have, for now, forestalled the costs of the Greek crisis. On March 3, the Greek government announced its latest austerity package, in effect a functional domestic default toward its own citizens on some of the previous political promises made to them, while the next day the immediate default risk for foreign bond holders seems greatly reduced. Which is a greater threat to democracy: a political or a financial default? We must wait and see for the answer.
But the games of chicken do not stop in the meantime. The Greek finance minister wasted no time in calling for the eurozone to reveal the so far hidden details of any financial aid on offer to Greece. In essence Greece is declaring to Berlin and Paris: "Now we have done our part in embracing austerity and proving that we will not default. It's up to you to prove what you mean by ‘eurozone solidarity.'" To emphasize the point, Finance Minister George Papaconstantinou warned that Greece might turn to the International Monetary Fund (IMF) if the eurozone does not "rise to the occasion."
To put it more broadly, Athens seems to be saying either: (1) "Provide us with financial assistance to lower our financing costs further, to perhaps a spread of 150 basis points, or we will go to the IMF and thereby undermine the credibility of a ‘European solution' to this crisis;" or (2) "Our 6.3-percent yield includes market expectations that you will provide us with future financial assistance, so unless you actually do so we will not be able to raise any more debt, and then we will be forced to go to the IMF and thereby undermine the credibility of a ‘European solution' to this crisis."
This is a game that Greece seems unlikely to win, however.
First, there is the issue about whether the IMF, with a governing board in which the eurozone members are overrepresented, would ever aid Greece over these members' objections. A related question is whether the IMF managing director, Dominique Strauss-Kahn, would agree to be the agent for a Greek bailout, which is very unpopular in Europe, if he harbors ambitions to return to French presidential politics in 2012, and if such a step involves overriding the opposition of other eurozone members. A possible indication is that he will apparently be out of the country when Greek Prime Minister Papandreou visits Washington next week. Greece's sovereignty has already been badly battered by this crisis by the fiscal prescriptions to which it has been subjected from the eurozone. Even so, Greece has the right to go to the IMF, and any political threat of eurozone members attempting to block that maneuver might be a further infringement of its sovereignty.
Second, the French and German governments have conflicting incentives now that the immediate Greek risk of default has abated. While the banks of these countries had the highest foreign exposure to a Greek default, they now earn extra income from the elevated interest yield on Greece's bonds—as outright default is avoided.2 The same attractive yield is clearly also why almost a quarter of the March 4 bonds were sold to Greek domestic banks. For the French and German governments to now provide concrete guarantees on Greek bonds, which would result in narrower spreads with German benchmark bonds, is arguably tantamount to using French and German taxpayers' euros to reduce the interest income of bonds held by French and German banks. This, at a time when these banks need all the extra-yield income they can get their hands on.
Third is the issue of future eurozone leverage over Greece. On Thursday EU Commissioner for Economic and Financial Affairs Olli Rehn said, "in 2011 and 2012, further measures will be necessary for Greece … for medium-term consolidation." Were eurozone governments to commit themselves publicly to a financial assistance framework today, they would—apart from inviting an immediate speculative attack on such a commitment—risk being obliged to adhere to it under unknown future circumstances. Much better to, as EU Commission President Barroso has recently done, merely make it clear that "concrete EU instruments exist to aid financially distressed governments in the euro area" while keeping the details secret.
It is far from clear that Berlin and Paris would commit to any actions to assist Greece in lowering its cost of raising capital when they face public hostility to any assistance to Greece and can instead sit back and rely on Greece to do the hard work of reviving private investor confidence without such aid. More likely, they will bet that in the end, if faced with market demands for even more austerity prior to the next debt offering in a few weeks, Greece will through yet another emergency austerity package bail itself out and avoid a catastrophic sovereign default.
The precise wording of the February 11 EU Council statement should be further recalled here: "Euro area Member states will take determined and coordinated action, if needed, to safeguard financial stability in the euro area as a whole." What this seems likely to mean is that the eurozone would act to avoid an outright Greek default, but since high Greek bond spreads by themselves do not constitute "a threat to the financial stability of the euro area as a whole," but rather perhaps signal the need for additional domestic austerity measures, the eurozone is unlikely to provide aid or details about an aid package to Greece now.
Indeed, were Berlin or Paris to provide details of any possible financial assistance in the absence of a default threat to their own banks, it would prove that true "European solidarity" with Greece has been lacking until now.
The emergence of European solidarity would be the clearly preferred option as a help toward further European integration, and would also be beneficial in terms of macroeconomics. But recalling the strict IMF-plus conditionality meted out to Greece by the eurozone so far and judging from the March 5 joint press conference in Berlin with Chancellor Merkel and Prime Minister Papandreou, no additional financial support is forthcoming. Words about political support will have to suffice for now. Solidarity is in short supply in Europe during this crisis.
In this series:
next: Greece Act IV: No Reason to Beware Any Gifts or Bailout for the Greeks
previous: Greece, Act II—More Kabuki than Tragedy
Notes
1. I am grateful to Robert Madsen in private correspondence for this description.
2. Obviously, the issue of precisely who earns what and when on holding Greek debt is highly complex and related also the precise financial statement accounting of them.
