Friday, July 22, 2011

It Depends Upon Your Definition of "Is"--Greek Bailout 2 or GB2!

Is Greece declaring default on it sovereign bonds?

To some, it depends upon your definition of “is”. 

Is a “selected default” or a “restricted default” a default?

There is only one answer in my book.  Greece is declaring default.

The reason Greece is defaulting is because Greece is insolvent.   (See my post from Wednesday,

At least some of Greece’s sovereign debt will be written down by around 20 percent in the new deal reached yesterday among European officials.  (I will not use the title “leaders” for this group of individuals.)  On Monday of this week, Greek bonds were selling at about a 50 percent discount.  As word that a possible agreement might be reached by European officials, the discount declined and the bonds were selling at 60 percent of par or 65 percent.

The question is, is this enough of a haircut?

There are other provisions: new longer-term bonds to replace shorter-term bonds, lower interest rates, and additional help for Portugal and Ireland.

However, it seems as if the most general comment on the new package is that the eurozone has bought itself some time.   

The first response of the financial markets has been positive reflecting that the Europeans have done something good.  However, as the news continued to sink in, markets backed off once again. (“Jitters over eurozone fringe snuff out rally”,

GB2 may not be enough.  And, then there is the fear of contagion: Is GB2 large enough to protect against the “Lehman Brothers” effect?  At first the failure of Lehman Brothers on September 15, 2008 seemed to be self-contained…but then problems occurred as financial concern spread to other areas and other firms. 

What about Portugal?  What about Ireland?  What about Spain…and Italy?

And, what about the United States?

There still are a lot of unanswered questions.

My response to this is two-fold.  First when you are in trouble, like Greece…and others within the eurozone…you need to act decisively and in a way that creates a belief that you mean to back up what you do. 

We work in a world of incomplete information.  We don’t know precisely what the correct amount of action is needed to solve a problem.  My view is that a leader needs to act decisively enough so that there is a good chance that the problem will actually be solved.  Also, the leader needs to act in a way that conveys to others that she or he is in charge of the effort and that whatever needs to be done will be done.

Second, the leader needs to create the belief that she or he will follow up on what has been done to close any gaps that might still be found to exist.  Financial markets must come to believe in that the leader will "stick at it" until the problem is corrected.

The officials in Europe have failed on both accounts.  First of all, they have denied and denied and denied that there was any problem they were accountable for.  It was always someone else’s fault. 

Second, the officials in Europe have never wanted to do more than the bare minimum in trying to correct the situation.  “How little can I get away with?” seems to be the question they ask. 

Third, no one seems to want to be in charge. 

Which leads me to my final point, the financial markets do not have much regard for anyone in the European hierarchy.  In this they seem to reflect the sentiment of the citizens of Europe. 

“Restricted default” or “Selected default”?  This seems to be like being partly pregnant: in my understanding you are either pregnant or you are not pregnant!

When will the European debt crisis be resolved?

It looks to me like the can has just been kicked a little further down the road.   

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