Greek default risk

Somewhere up around 110%, don\’t you think?

A growing chorus of voices is urging the Greek government to restructure its debt as fears grow that a €110bn bailout has failed to rescue the country from the financial abyss and is forcing ordinary people into an era of futile austerity.

\”It\’s better to have a restructuring now … since the situation is going nowhere,\” said Vasso Papandreou, whose views might be easier to discount were she not head of the Greek parliament\’s economic affairs committee.

Worth pointing out that Greece has been in default on its external debts for fully 50% of its time as an independent country since 1829. Further, that there have been some 800 sovereign defaults over the centuries, from Edward III onwards, to Russia and Argentina at the turn of the last century.

With euro base rates at 1.25%, but Greek bonds at 12.99% (so I\’m told), the market is already pricing in a very high liklihood of some sort of restructuring.

There\’s one more part to this. As Duncan has pointed out, it isn\’t just the interest rate that causes problems. It\’s the maturity profile of the debt that does as well: when do you have to roll over earlier loans?

Now Duncan points to the UK\’s rather long average maturity (over 14 years) as an argument that we\’re safe. Safer, certainly, for it puts what we might call liquidity concerns (ie, that we can\’t roll over maturing debt, because we\’ve not got much of our stock of debt maturing in any one near coming year) somewhat to rest but perhaps not solvency ones.

Greece isn\’t in that situation at all, their maturity profile is much worse. They\’ve got loans that they originally contracted in the heady days when they paid the same interest rate as Germany coming due, loans that they\’re going to have to roll over at these new much higher rates. That\’s what\’s going to kill them, not the current borrowing requirements needing to pay 12%, but the entire stock of €340 billion needing to be rolled over, in coming years, and refinanced at those rates.

And, as I say, their maturity profile is such that it\’s not many years before the whole lot will need refinancing.

Which brings us to a nice point made by Ken Rogoff: that a shortening of the maturity of the debt is a sign of a coming apocalypse. It\’s a simple enough mechanism. As debt burdens rise, it\’s longer interest rates which rise more than shorter term ones. If you\’re thinking about the risk of default before lending then of course the possibility of a default looms larger in the mind when thinking about lending to someone for 30 years rather than 12 months. So the debt issuer, seeing these different interest rates, has a natural tendency to issue shorter term debt….and shorter term debt.

Thus the maturity profile of the stock of debt shortens, more needs to be rolled over in any one year and the issuer becomes ever more exposed to a spike in interest rates. Because an ever greater part of the stock will need to be refinanced at those new, higher rates if they do indeed come about.

Indeed, Rogoff goes on to argue that a shortening maturity is an indicator of likely coming problems.

And at some point, it becomes Ourobouros, the whole problems starts to eat itself. Interest rates rise high enough that only issuance at the short end of the maturity profile is even possible, but this just delays the reckoning until that debt itself needs to be rolled over.

At which point, some sort of default or restructuring is simply inevitable.

Fortunately, we\’ve had those 800 experiences in what to do here. We\’ve even got the infrastructure of the people to deal with it. There\’s the Paris Club for official lenders, the London Club for private sector (note, lenders, not issuers).

I can\’t see any way out of this other than default (and that goes for Ireland and Portugal as well). And while it sounds most odd to be relying on France in a moment of crisis, I really would suggest getting those phone lines humming to those guys in Paris.

Just can\’t see any other way it\’s going to play out.