Will Greece Default On Its Debt?
Feb 03, 2015
An old joke is that if you owe a thousand dollars, you are at the bank’s mercy. If you owe a million dollars, then the bank is at your mercy. The new Greek government has heard this joke, or else they recall that in the 6thcentury B.C., Solon was made magistrate and cancelled the debts of poor people. Greece is coming close to repudiating its debt. In this article, I’ll explain why they might do that and what the consequences would be for the global economy.
Greece owes a lot of money. It’s debt is 176 percent of its gross domestic product, a high figure but not the worst in the world. Debt service now takes costs a little over four percent of GDP per year, though some calculate the cost to be just 2.2 percent when various sweeteners are considered.
(It’s complicated now because of past restructuring. In the old Greek debt crisis, bankers and other private debt holders turned their Greek bonds over to European governments and took a 75 percent haircut. Twenty-five percent is better than nothing. Now most of that debt is held by governments. Some of the interest does not need to be paid annually, so the actual interest payments are lower than the total accrued interest. It’s like when your credit card company allows you to skip a payment, but will charge you interest on that skipped payment later.)
Greece’s “primary budget,” which is calculated before interest, is in surplus. Total debt declined slightly, thanks to asset sales. (In the accompanying chart, positive numbers show a reduction in debt, negative numbers an increase in debt.)
Now suppose that Greece just repudiated its debt, saying “We won’t pay. Don’t ask us.” They save all of the interest expense, they stop worrying about repaying bonds as they mature, and they increase government spending. What’s not to like about that?
Some critics will comment on the ethics of borrowing and refusing to repay, but Greek politicians may well sound like Elizabeth Warren and claim it’s the lenders’ fault. Perhaps the banks enticed Greece to borrow recklessly. Ethical issues are unlikely to stop a default.
Practicality could prevent default, as it does for lots of families. We know that if we miss payments, our credit score takes a dive and we have trouble borrowing in the future. However, suppose you didn’t think you would need to borrow in the future? Walking away from debts may be attractive to ethically-challenged debtors.The more far-sighted debtor would wonder if additional loans might be needed in the future. Perhaps Greece’s budget is in surplus (excluding interest) now, but what if something happens? Suppose expenditures are increased but tax revenues don’t rise as much as expected. With no other organization on the planet willing to lend money to them, the Greeks could be in trouble. The defaulter’s response might be, “We’ll be careful.” I don’t believe it, but I can believe that the debt defaulter might believe it. Or a politician might say the words with as much truth as any politician normally uses.
In this position, the Greeks are holding the strong hand in negotiations with the rest of Europe. If economic restructuring requirements are not eased, the Greeks can walk away from the bargaining table. Not only would European governments end up holding worthless debt, but European politicians would be highly embarrassed. To a politician, of course, losing the next election is a far greater threat than the loss of billions of Euros.
What’s likely to happen? Look for the European governments to cave in. They will “restructure” the debt and relax their behavioral requirements. During the American financial crisis, the phrase “extend and pretend” was used on commercial mortgages. Extend the maturity and pretend it will all work out. On the books, it will look like the assets are there. In reality, the bonds will be worth hardly anything at all. And the likelihood of Greece ever working its way out of the problem will be lower than ever before.
The global consequences of this outcome will probably be minor. The money that has been lent to Greece has pretty much been lost already. The timing of the recognition of this loss is not going to change much. Other countries will have a harder time getting credit, but that’s already the case. The lesson has been learned, though like most lessons, it will have to be re-learned.
Source: THE Forbes