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Now that the negotiations over financial assistance to Athens have started among European representatives, the IMF, and the Greek government, what outcomes should we expect?
First, we need an honest price tag and a long-term economic restructuring plan with a chance of success. The eurozone stuck its head in the sand a few weeks ago and only gave a number for its willingness to support Greece during 2010, amounting to €30 billion, plus an estimated €15 billion from the IMF, explaining that "financial support for the following years will be decided upon the agreement of the joint [program]."
Obviously eurozone leaders, for political reasons, wanted to keep the "bailout price" at a minimum—in this case €30 billion. If so, they failed spectacularly, as Greek bond market spreads have widened dramatically since their announcement and are now at their highest level since the introduction of the euro in 1999.1 In effect, bond markets are signaling that the eurozone and the IMF will have to carry the cost of lowering Greece's cost of capital on their own.
The eurozone and the IMF should now own up to this fact and spell out their projections of total official sector financial assistance during a multiyear joint program—and the breakdown of respective shares of eurozone and IMF financing. This number is certain to exceed €30 billion, and is probably closer to €100 billion. Without a more realistic number, it would be politically reckless for eurozone governments or the IMF to authorize any payments to Greece.
Equally important is the need for a credible long-term Greek economic restructuring program. What must the Greek government implement and what must the Greek population endure as part of such a multiyear aid program? Surely in 2011 and 2012 Greece will need to take steps beyond the announced plan to reduce the Greek deficit to 3 percent of GDP by 2012.
It is far from certain that the eurozone governments will be willing to commit their taxpayers to a multiyear program costing €80 billion to €90 billion (with the remainder paid by other members of the IMF). Likewise, the Greek government may not be willing or able to implement the kind of dramatic structural reform and austerity measures the situation demands.
Second, the joint negotiations must prepare (without necessarily publishing) a "plan B for Greece"—a well-organized debt restructuring and a substantial haircut for existing private creditors. It is time to create "Barroso Bonds" for Greece, named after the European Commission president José Manuel Barroso, resembling the "Brady Bonds" that helped mostly Latin American countries reduce their debt burden after 1989.2 (They were named after the first President Bush's Treasury Secretary Nicholas Brady.)
Given Greece's enormous debt stock, a sudden and disruptive default will inflict substantial losses on private bondholders. Designers of the "Barroso Bonds" could call for haircuts for creditors but also provide incentives for them to participate in an orderly debt restructuring.
Like "Brady Bonds," a "Barroso Bond" plan must provide a menu of several different bonds tailored to the heterogonous circumstances and incentives of the private creditors.3 They should offer creditors a way to reduce their exposure to Greece (exit now, but at a price), while providing the prospect of gains over time on their new debt levels—in other words, a formula for them to "stay in and gain."
New funding sources could come in the form of eurozone sovereign guarantees of "Barroso Bonds,"perhaps simply by making them eligible as European Central Bank (ECB) collateral. (Note that existing Greek debt in a default would automatically be excluded from ECB collateral status.) Or the bonds might be secured against future European Union budget transfers to Greece. In this manner, "European solidarity" would help Greece undertake an orderly debt restructuring. Given that the total price tag "postrestructuring" would be far smaller than what we are seeing now "prerestructuring," its political palatability will likely increase.
Forcing a haircut on to all existing private creditors will be extremely difficult, and some bondholders may resist. However, it is clear from Bank for International Settlements (BIS) data that much of the foreign exposure to Greek sovereign debt is concentrated on the books of eurozone banks or ultimately with the ECB through their collateral system.
Given that many eurozone banks may face capital shortages from losses on Greek debt resulting from a sudden default, eurozone governments (and the ECB itself) surely hold significant leverage to encourage participation in a "Barroso Bond plan." To avoid a run on some eurozone banks, an explicit government guarantee to such institutions (i.e., merely repeat what was made explicit earlier in this crisis when Lehman collapsed) should accompany any announcement of a "Barroso Bond Plan." Similarly, to avoid contagion to other weak eurozone countries, an announcement of a "Barroso Bond plan" must be accompanied by announcements by other governments, especially the Portuguese, of their own steps to avoid the fate of Greece.
Coordination of eurozone fiscal policies will ironically never be more urgent than as part of a "Barroso Bond plan" for Greek debt restructuring.
Notes
1. It is now over 500 basis points to German bonds.
2. Naming rights for these bonds present a problem, given the multiple institutions involved. It was easy with Nicholas Brady, who as US Treasury secretary was naturally the key decision maker and blessed with a surname starting with "B" as in bond. The Greek situation is more complicated, as the institutional leadership role remains undefined. Will it be the eurozone giving birth to "Juncker Bonds"? Germany creating "Schauble Bonds"? The whole of the European Union perhaps yielding "van Rompuy Bonds"? Or the European Commission creating "Barroso Bonds"? Certainly the latter option has the best sounding name most likely to catch on.
3. Two now EU members—Poland and Bulgaria—issued Brady Bonds in 1994. See Izvorski (1998).
