So, Greece defaulted. In the beginning, May 2010 to be precise, Europe and the IMF put up the largest loan in history supposedly to avert any kind of debt restructuring.  Then, when by the summer of 2011 it had become clear that debt restructuring was unavoidable, Europe embarked on ten months of navel gazing and a series of odd negotiations in order to effect the type of debt restructuring that would not, we were told, trigger CDS contracts. This week the default occurred and the CDS contracts were triggered. In terms of the troika’s own criteria, this was a spectacular failure to meet both targets.

But was there a silver lining, as the powers-that-be say there is? Did Greece’s debt enter a sustainable path, even if belatedly? Again the answer is a definite No! Exhibit A is, of course, the fact that the new English Law bonds issued by the Greek state (to be swapped for the distressed older Greek Law government bonds) are trading at prices which shriek: “Fresh default coming soon!” Could this be another instant when markets are wrong? So, let’s look more closely under the bonnet of the new Bailout-PSI combination.

Why a Fresh Default/Haircut is inevitable

The success or failure of a haircut depends not on its extent but on the viability of the debt that remains. When Greek and European politicians celebrate the fact that almost €100 billion have been shaved off Greece’s public debt, they state a useful fact but use it as a smokescreen that veils the numbers that count the most.

Suppose I owe a bank €100 thousand and the following agreement is struck: The bank will write off €53 thousand and will receive from me, in return, €15 thousand up front plus, say, 32 interest bearing IOUs of €1000 face value each and long maturity (assume also that the interest rate on these IOSs is around 4%). Has my debt been rendered serviceable? It depends. First, it matters that, since I do not have it, I must borrow the €15 thousand cash that I have promised my bankers. Who from? My metaphor is strained here. One could say, from ‘family’ (although families come in different guises, not excluding the Sicilian type). Secondly, as part of this deal, I must borrow immediately (or find it in the not distant future through liquidating whatever assets I have) another €30 thousand to put in a trust fund that will be used as collateral in case my IOUs bounce in the future (or in case I fail to meet my interest rate payments). Thirdly, for this deal to go through, I must bind myself to a behavioural code (also known as austerity) that most analysts believe will further shrink my already diminishing income flow over the next few years. Read the rest of this entry »