One feature of the Greek sovereign debt crisis, which is
widely misunderstood, is the following. Since the start of the crisis the Greek
sovereign debt has been subjected to several restructuring efforts. First,
there was an explicit restructuring in 2012 forcing private holders of the debt
to accept deep haircuts. This explicit restructuring had the effect of lowering
the headline Greek sovereign debt by approximately 30% of GDP. Second, there
were a series of implicit restructurings involving both a lengthening of the
maturities and a lowering of the effective interest rate burden on the Greek
sovereign debt. As a result of these implicit restructurings, the average
maturity of the Greek sovereign debt is now approximately 16 years, which is
considerably longer than the maturities of the government bonds of the other
Eurozone countries. These implicit restructurings have also reduced the
interest burden on the Greek debt. The effective interest burden of the Greek
government has been estimated by Darvas of Bruegel to be a mere 2.6% of GDP.
This is significantly lower than the interest burden of countries such as Belgium,
Ireland, Italy, Spain and Portugal.
As a result of these implicit restructurings the headline debt
burden of 175% of GDP in 2015 vastly overstates the effective debt burden. The
latter can be defined as the net present value of the expected future interest
disbursements and debt repayments by the Greek government, taking these
implicit restructurings into account. Various estimates suggest that this
effective debt burden of the Greek government is less than half of the headline
debt burden of 175%.
From the preceding it follows that the effective debt burden
of the Greek government is lower than the debt burden faced by not only the
other periphery countries of the Eurozone but also by countries like Belgium
and France. This leads to the conclusion that the Greek government debt is most
probably sustainable provided Greece can start growing again (so that the
denominator in the debt to GDP ratio can start increasing instead of shrinking
as is the case today). Put differently, provided Greece can grow, its
government is solvent.
The logic of the previous conclusion is that Greece is solvent
but illiquid. Today Greece has no access
to the capital markets except if it is willing to pay prohibitive interest
rates that would call into question its solvency. As a result, it cannot
rollover its debt despite the fact that the debt is sustainable.
There is something circular here. If Greece is unable to find
the liquidity to roll over its debt it will be forced to default. The expectation
that this may happen leads to very high interest rates on the outstanding Greek
government bonds reflecting the risk of holding these bonds. As a result, the
Greek government cannot rollover its debt except at prohibitive interest rates.
The expectation that the Greek government will be faced with a liquidity
problem is self-fulfilling. The Greek government cannot find the liquidity
because markets believe it cannot find liquidity. The Greek government is
trapped in a bad equilibrium.
What is the role of the ECB in all this? More particularly,
should the OMT-program be used in the case of Greece? The ECB has announced sensibly
that OMT-support will only be provided to countries that are solvent but
illiquid. But, as I have argued, that is the case today for Greece. So what
prevents the ECB from providing liquidity? There is a second condition: OMT
support is only granted to countries that have access to capital markets. This
second condition does not make sense at all, because it maintains the circularity
mentioned earlier. Greece has no access to capital markets (except at
prohibitively high interest rates) because the markets expect Greece to
experience liquidity problems and thus not to be able to rollover its debt.
The explicit aim of the OMT-program was to prevent such
self-fulfilling expectations that can push countries into a bad equilibrium. It
is appropriate to quote Mario Draghi when he announced the OMT-program on 6th
September 2012: “The assessment of the
Governing Council is that we are in a situation now where you have large parts
of the euro area in what we call a “bad equilibrium”, namely an equilibrium
where you may have self-fulfilling expectations that feed upon themselves and
generate very adverse scenarios. So, there is a case for intervening, in a
sense, to “break” these expectations”[1]
Greece today fulfills the conditions for liquidity support as spelled out by
Draghi in 2012. Yet Greece is excluded from this support, and as a result it is
kept in a bad equilibrium.
The use of OMT to provide liquidity support to Greece is made
difficult by the fact that public authorities hold the largest part of the
Greek debt. To solve this problem it would be necessary that these public
authorities recognize that the market value of their claims on Greece debt is
worth a fraction of the nominal value. These public claims could then be sold
in the market at a price that comes close to the net present value of the
future disbursements (interest plus capital). At that moment the ECB could
extend its OMT-promise to these assets (bonds) thereby creating a market for
them.
I am aware that this solution creates a political problem.
Governments of the creditor countries will have to recognize the losses they
have already made on their claims on Greece. Politicians prefer to live in a
fictional world allowing them to pretend no losses have been made so that they
can hide the truth to their own taxpayers. The solution proposed here forces
these governments to come out with the truth, i.e. the losses have already been
incurred. I conclude that providing liquidity to Greece is possible provided
governments stop hiding the truth.
All this teaches us two lessons. First, the objectives of the
creditor nations, including the ECB, that today add tough conditions for their
liquidity support is not to make Greece solvent but to punish it for
misbehavior. The punishment is deemed to be necessary to avoid moral hazard
risk. It is perfectly understandable that creditor nations are concerned about
moral hazard. But it is precisely the desire to punish Greece by imposing
additional austerity that makes it so difficult for Greece to start growing
again and to extricate itself from the bad equilibrium.
A second lesson concerns the credibility of the future use of
OMT. It clearly appears from the Greek
experience that the willingness of the ECB to use the OMT program is very
circumscribed. It is circumscribed by the ECB’s desire to solve a moral hazard
problem. The ECB seems to be saying that OMT will only be used when it can be
certain its liquidity support will not trigger misbehavior. And this can only
be achieved by imposing tough conditions. Behind the gloves of OMT is hidden a
big stick. It is doubtful that future governments that experience payment
difficulties will accept to be beaten up first before they can enjoy the OMT
liquidity support.
Now that the European Court of Justice has given the legal
clearance for OMT, the question arises whether the moral hazard hurdle to the
use of the OMT will easily be overcome. I conclude that the credibility of the
OMT-program to be used in times of crises is limited.