Greek exit would be costly
FEW KNOW HOW to navigate through complex negotiations between governments and financial institutions better than Charles Dallara.
Representing more than 430 global financial institutions as the head of the Institute of International Finance, Dallara was the key negotiator for private investors in the biggest debt restructuring in history in March, when more than €100 billion of Greek debt was wiped out.
Despite this extraordinary writedown, Greece remains in a politically and financially febrile state, heading for a second election in just over a month and with the country’s membership of the euro hanging in the balance.
Dallara says that the effect of a Greek exit from the euro would be “somewhere between catastrophic and Armageddon”, admitting that this statement is “a slight exaggeration for effect, but only slight”.
“If you look at the numbers and the chaos that is likely in the markets and the contagion effects in the markets, both in Europe and globally, it is hard for me to conclude that this is a course that any logical analytical process would lead you toward,” he said.
“I admit that politics and popular sentiment aren’t always logical but I am troubled by the apparent casualness with which some European officials are treating this.”
The European Central Bank has an exposure to the Greek economy through its banking system, government and companies of €170 billion – a figure which is roughly the equivalent of Irish GDP and double the paid-in capital of the ECB.
“If you look at European institutional and governmental exposure to Greece right now, the idea that you could remove Greece and simply cut off this painful limb from an otherwise healthy euro zone is simply dreaming,” he said.
The European economy could not cope with the strain of such a move and it could also undermine a shaky global economic recovery.
“The Aegean Sea may not be around the corner but it would feel like it in my view for Ireland and the rest of Europe,” he said.
He doesn’t believe a Greek exit is a foregone conclusion or that it is even highly likely but he admits that it is possible.
“One can’t look at what is happening in Greece today and rule it out. But I continue to believe that the cost to Greece, the cost to Europe and the cost to the global economy of Greece exiting the euro are all sufficiently large that they will cause Greek leaders and European leaders to reflect long and hard before taking Greece down this road,” he said.
Europe should learn from the mistake made three and a half years ago when the US failed to save Lehman Brothers, he says.
“In some ways, the issue of a Greek exit has more ominous potential to the global economy than Lehman’s did,” he said.
Earlier this week, Greek president Karolos Papoulias called another election after agreement could not be reached on the formation of a coalition government following the May 6th poll that left opponents of Greece’s EU-IMF bailout with a majority of the vote.
Polls point to a victory for the radical left in the re-run of the election and this has raised questions about Greece’s ability to remain in the single currency and to keep insolvency at bay. The stakes for the euro could not be higher.
Dallara reads the political situation in Greece as “an expression of pent-up frustration and fatigue by the people of Greece searching for new leadership”.
It is not just fatigue with austerity, to which the vote is most easily but mistakenly attributed, he says. “We in the rest of the world and the rest of Europe have to exercise a bit of patience to let the democratic process run its course. They will have to find their way through this,” says Dallara.
Greece’s decision on Tuesday to pay €435 million to international bondholders who did not participate in the debt exchange negotiated by Dallara at par was “at one level regrettable and at another level understandable”, he said.
The bonds traded as low as 66 cent in the euro last December and the payment in full this week must have infuriated the 96 per cent of bondholders who signed up to the €100 billion debt write-down which Greece had described as its “best” and “only” offer.
The move was “unwelcome”, says Dallara, but creditors in the March deal had to be aware of the extraordinarily difficult political circumstances in which the pay-off of “hold-outs” was made.
“Non-payment could easily have been misinterpreted in today’s market and political uncertainty as a move toward a broader default,” he said.
Could this pose difficulties for Greece or another country if there is another proposal made to creditors to write down more debt?
“I do have to say that I am somewhat concerned that the potential – and I don’t say that it is the reality – that this could create problems of precedent for the future to restructuring of sovereign debt on a voluntary basis,” he said.
Dallara says that Europe needs to change course slightly, “not 180 degrees but 45 degrees”, to resolve the crisis once and for all.
“The emphasis on fiscal responsibility is right; the emphasis on short-term budget cuts is overdone,” he said in what will be music to Irish ears. Cutting short-term budgets was taking “too much wind out of the economy”.
Europe was moving in the right direction by building a firewall in the European Financial Stability Facility (EFSF)and subsequently the European Stability Mechanism (ESM), and with the ECB’s liquidity measures.
Dallara believes there needs to be another round of long-term cheap refinancing and bond-buying by the ECB in addition to further interest rate reductions.
“They need to more definitively up the scale of their follow-up, not by additional trillions, but certainly by a noticeable amount,” he said.
As someone who represents financial institutions, it is hardly surprising to hear Dallara call for deadlines under the new Basel III bank capital rules running up to the start of 2018 to be extended. These are having an “unnecessarily adverse effect on credit availability in Europe”, he says.
Beyond these measures, Dallara says there needs to be a “much more convincing game plan” towards fiscal integration in the euro zone to prop up a structurally flawed monetary union.
“A clearer timetable, as ambitious as it may seem, toward eventual political union may need to be given serious consideration.
It is, of course, for the leaders of Europe to decide how to deal with fiscal and political integration.
“But, certainly on the fiscal front, I would say Europe stands at a crossroads where it either has to vote convincingly for an acceleration of integration or the fragmenting pressures that we see today will run a serious risk of pulling Europe apart.
“I don’t think that the current path, as calibrated, is sustainable,” he said.
Dallara says Ireland has rebuilt its credibility, if not its economy, and that it has performed more impressively than any other country in fixing its finances and facing up to its problems. This will give Ireland flexibility in dealing with medium-term fiscal targets.
“The Irish performance has earned credibility in the markets, although it has yet to pay significant dividends,” says Dallara. “But I am confident that it will.”
That credibility has given Ireland “a place at the table” to agree a deal on the promissory notes covering the bailout costs of Anglo Irish Bank and Irish Nationwide, and involving tracker mortgages at AIB and Permanent TSB, he says.
“That, at the margin, could be meaningful,” says Dallara.
Giving the EFSF and ESM the flexibility to inject funds directly into banks in response to concerns about Spain’s banks could help Ireland, he says, and it “does behove” Europe to consider this.
He does, however, want more definitive stress tests and greater transparency in the Spanish banks before knowing whether the country’s lenders require government or euro zone support.
Spain’s banking troubles are different from those of Ireland, says Dallara; the country has two global institutions which are “broadly healthy, have sufficiently diversified earnings and sufficiently well managed balance sheets”.
Dallara says there are similarities between Europe’s crisis and the sovereign debt crises of Latin America in the 1980s, which occupied much of his time when he worked at the US Treasury.
Unlike the Latin American crises, the financial markets won’t give Europe close to a decade to resolve the currency bloc’s issues.
“What makes Europe much more difficult is that you have got a monetary union without a fiscal union on the one hand, which I think is structurally flawed at the roots, and secondly you have a decision-making apparatus that is extraordinarily cumbersome, occasionally bordering on the dysfunctional,” he said.
During his discussions on the Greek restructuring, Dallara not only had to negotiate with the Athens administration but with 16 other euro zone governments, including smaller states which “wanted to have a voice in every small piece of the negotiations”.
“In my view, the euro zone needs a much cleaner majority-based decision-making apparatus if it is to be able to cope with the pressures that exist today in the markets,” he said.