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While much of the financial world has focused recently on the upheaval at the International Monetary Fund, a series of other events in Europe this week brought additional uncertainty to the circumstances surrounding the continuation of the Greek bailout program after 2012. A cacophony of opposing public statements is inevitable when multiple democratically elected policymakers and a genuinely independent central bank are engaged in a zero-sum game. But recent events have marked a low point in the European Union's ability to manage even minimum message discipline. It is increasingly evident that the euro-group ought to find a new leader and public spokesman who masters the art of keeping quiet when there is obvious deep-seated disagreement among the key policymakers about how to proceed.
It is evident that the European Central Bank (ECB) is vehemently against any type of Greek restructuring at present. Because its Governing Board wields control over its collateral policy—i.e. it can reject collateral from individual issuers (like Greece)—it quite possibly has the ability to block policymakers' attempts at implementing any type of Greek restructuring, at least temporarily.
The ECB apparently remains too worried about the immediate effects of any restructuring of Greek debt on the still precarious European banking system, and also about the risk of contagion to Spain and Italy from undermining the "risk free status" of euro area sovereign debt. As long as this remains the principal concern of the ECB, given its pivotal role in maintaining financial stability in the euro area, policymakers' options look severely restricted. This is a true display of supra-national independent central banking!
But if you assume that its opposition to restructuring arises from of contagion effects, the ECB's opposition will not likely last indefinitely. Indeed, if it did, the ECB would be saying in essence that private sector creditors would always be bailed out fully in the euro area. That of course would present financial markets with untenable incentives and guarantee that the next crisis arrives soon.
In a few years, a better capitalized euro area banking system and a Spain and Italy on firmer fiscal footing and with better growth prospects might alter the central bank's calculation. After all, part of the ECB's mandate is to maintain financial stability in the euro area. If a restructuring can be carried out in the future without too much fallout, Frankfurt might agree. Clearly not now though!
Meanwhile, in the ro area declaration endorsing the Portuguese bailout program , policymakers provided a strong hint of one of the policy tools they are likely to employ in renegotiation of the Greek program. After spelling out the sources of official sector money for Portugal, the euro area finance ministers stated: "At the same time, the Portuguese authorities will undertake to encourage private investors to maintain their overall exposures on a voluntary basis."
This means that while public money (€78 billion) will flow to Portugal, attempts will be made to limit the transfer of exposure to Portugal from the private to the public sector. These attempts will be in the form of "encouraging" private investors to roll over their debt to Portugal. This is quite similar to the successful "European Bank Coordination Vienna Initiative," during which systemically important EU-based parent banks of subsidiary banks in Central and Eastern Europe and their home and host country supervisors came together with fiscal authorities and central banks to prevent a damaging banking crisis in the region.
Expect pages of the same playbook for Greece in 2012, when more public money will be required to finance the Greek deficits, while quite a lot of old Greek debt also comes due. The euro area taxpayers will provide some of the 2012 financing for Greece, while various European banks (many of the same parent banks involved in the Vienna Initiative in fact) will be "encouraged" to roll over their exposure to Greece, reducing the need for more public money.
According to the 3rd Review of the IMF Program (table 13) , Greece in 2012 has medium and long-term debt of €35.2 billion coming due and is scheduled to raise €26.7 billion in new medium and long-term private financing. Assuming that a sizable share of the €35.2 billion due in 2012 is owned by "politically vulnerable" euro area financial institutions (e.g. banks, insurance companies and even pension funds), quite a bit of that looks likely to be rolled over. This would have the benefit of reducing the need for more euro area taxpayers' money flowing to Greece.
Combined with rapid progress on Greek privatizations and perhaps even some purely voluntary Greek debt writedowns by large and healthy euro area banks, euro area political leaders might then have the political cover to distribute more taxpayer funds. All this to buy more time until the European banking system and Spanish and Italian finances are healthy enough to escape contagion from a Brady-type restructuring of the Greek debt carried out with the ECB's consent.
