Financial engineering to the rescue of Athens

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Athens is struggling to convince its euro zone creditors to talk about debt relief. It’s because it’s not urgent. But if negotiators resolve the immediate crisis, which could lead to bankruptcy within weeks, debt relief should be on the table.

Debt relief is not the focus of ongoing discussions, as Greece’s borrowings have already been restructured once, in 2012.

The debt is still enormous – 313 billion euros, or about 353 billion dollars – 175% of Greek gross domestic product. But the bulk, around 184 billion euros, is now owed to eurozone governments and pays low interest. Also, Greece doesn’t have to start paying it back until 2020 and then has over 30 years to finish. The so-called discounted value of this debt, what it is worth today, is therefore much lower than its official face value.

Unfortunately, that’s not the whole story. Greece has four other sources of borrowing: 27 billion euros owed to the European Central Bank; 20 billion euros due to the International Monetary Fund; debt to private investors; and short-term treasury bills. Private debt is not an immediate problem, as most of it has also been spread over a long period. Neither do treasury bonds, as Athens is always able to renew them when they expire.

But ECB and IMF debt is problematic because most of it comes due within the next five years. In fact, there is a crisis in the coming months, with more than 10 billion euros in refunds due by the end of September.

The catch is that IMF and ECB debt cannot be rescheduled without breaking rules and treaties. That is why the objective of the current talks is to lend more money to Greece, so that it can fulfill these obligations.

Greece and its creditors agree that this is an immediate need. Where they disagree is on the conditions that should be attached to the additional loans. This is why there is now a serious risk of bankruptcy for Greece.

If that possibility is avoided, the issue of longer-term debt relief will be on the table. Not only does Greece want it; the IMF thinks it is necessary to make the country’s debt sustainable.

The euro zone will also be under pressure to provide even more loans to Athens as the money remaining in the current bailout program will not be enough to cover all repayments due to the ECB and IMF. In addition, the country has other needs, such as the payment of unpaid bills to suppliers, the recapitalization of Greek banks and the repayment of loans it has forcibly wrested from local authorities in Greece.

Since the Eurozone will not accept a write-down of its loans, the obvious solution is to give Athens an even longer holiday before it has to start repaying that debt and to lengthen the period in which it has to finish do it. The present value of the debt would decrease again.

Some observers complain that such a move would do nothing to reduce the overall size of Greek debt. While it wouldn’t matter if everyone was rational and focused on present value, it could still undermine confidence and thus prevent a good economic recovery.

This is where some financial engineering can come in handy. The Greek government has proposed splitting most of the euro zone’s debt into two parts: one would carry a higher interest rate; the other would pay no interest at all. Athens then wants this “zero coupon” debt to be gradually canceled.

While the Eurozone will not agree to the cancellation, the debt-splitting program could be modified to make it workable. The key idea is that zero-coupon debt will have a present value well below its face value. If Greece could find organizations to take on this responsibility for a payment equivalent to its present value, it would significantly reduce the face value of its debt.

Companies and infrastructure projects could be interested. They would basically receive long-term loans, which they would repay all at once with all interest accrued. This is the type of financing that the European economy could need, because it must support investments. The twist is that the companies or projects would receive the initial money from Greece but repay the loans to creditors in Athens. These would have to accept a change in counterparty, but they would not have to cancel the loans. Such a program could reconcile Greece’s demand for lower overall debt with the reluctance of eurozone governments to acknowledge to their taxpayers that they lost money lending to Athens.

Some creditor countries will, of course, wonder why they should offer even more aid to Greece. Part of the answer is that the collapse of a country so close to home is not in their interests.

But it is also ethical. Other eurozone countries prevented Greece from defaulting on its debts at the start of the crisis because they feared it would bankrupt their own banks, which had lent most of the money to Greece. Athens. So they bear part of the blame for Greece’s predicament and part of the responsibility for fixing it.

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