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Greece is the word

Grace Concelman | Monday, October 31, 2011

What do you get when you lock the leaders of the EU into a conference room and tell them they can’t come out until they have a comprehensive plan to save the continent from impending financial doom?

A haircut.

Wait — a haircut? Did the eurozone leaders propose a mass trip to barbershops across the continent as a way to stimulate their economies?

No, this is a different kind of haircut, but it’s just as slick as John Travolta’s hair in Grease.

The latest solution to avoid a Greek debt default is a 50 percent haircut on Greek bonds, which means that the private bondholders can trade in their old battered bonds for shiny new ones worth half the value. The proposal is expected to reduce Greece’s debt levels to 120 percent of GDP by 2020 (it’s currently greater than 160 percent). That’s still an uncomfortably high level of debt, but for now it avoids a default.

A 50 percent reduction in the value of bonds isn’t a default? No, it very intentionally is not. The drafters of the plan stuck a tricky little word in front of the bond exchange language: voluntary. Some lawyers have decided that since the haircut is “voluntary” it is not technically a default. So, no one is forcing the bondholders to accept the exchange proposal and cut their holdings in half, but somehow leaders expect participation to be very high.

We had better hope participation is high and the plan works as expected. This is the third “comprehensive” plan this year to prevent a Greek default, so the track record is not so good.

Greece itself is not the problem; countries do occasionally default. The problem is that Greece is deeply connected via the Euro to a whole lot of other struggling countries. Like a group of friends trying to stay on their football bench while dancing an Irish jig, if one goes down, the whole section goes down along with them.

If Greece tips the balance, Portugal, Ireland, Italy, Spain and now even France could go down along with it, or at least their financial systems could be mired in a crisis worse than 2008.

So, the Euro complicates the whole situation. The ECB, keeper of the Euros, has the power to print money to ease the pain, but printing money causes inflation and Europeans are deathly afraid of inflation. Instead, in May 2010, the ECB decided to create a bailout fund to throw money into the Adriatic. The European Financial Stability Fund (EFSF) lends financial assistance to struggling countries using money collected from other eurozone states.

But, after an earlier bailout of Greece and subsequent bailouts of Portugal and Ireland, there isn’t enough money left in the EFSF, so the other part of the latest solution is to leverage the EFSF.

Leverage in finance can take a lot of different forms, but essentially it is borrowing in order to increase returns. The EFSF would raise money by selling insurance to bondholders against default on countries like Spain and Italy that would hopefully never be paid out. This seems absurdly cyclical considering that over-leverage played a role in creating the whole mess. Now they want to use it to get out?

Shifting the debt around and likely slapping on a AAA rating to make it look prettier doesn’t seem like a solution, but then again, neither does a default.

It’s like the end of Grease when Olivia Newton John can either sew herself into leather pants or risk losing John Travolta forever. Neither is a great option, but of course she picks the man and together they ride happily off into the sunset in a flying car.

Hopefully the leather pants will have the same effect for the EFSF.


Grace Concelman is a senior majoring in finance and philosophy. She can be reached at [email protected]

The views expressed in this column are those of the author and not necessarily those of The Observer.