Failure being devastating does not ensure success | FT Alphaville

Failure being devastating does not ensure success

There are only bad or very bad options left for Greece, the occasional fascination with this or that SPV-solution notwithstanding.

Chart du jour to bring home this point:

That’s from a big new Societe Generale note on the crisis which includes its economist Michala Marcussen trying to quantify a ‘disorderly’ Greek default in terms of economic costs. In SocGen’s words, these are




(Last one’s the cost if Germany deigns to leave the euro.) Basically, the more expensive it looks, the more everyone accepts that “orderly” default remains the only game in town. Right?

So – note the extremely high estimates for the destruction wrought to the Greek economy by what SocGen calls a “hard” default (including Greece’s own exit from the eurozone), at the bottom right of the chart.

We’ll get to the reasoning behind these estimates in a moment. But we should point out SocGen isn’t even very confident about tweaking the current debt swap to allow further bondholder write-downs, as “shifting to a PSI programme with a 50% haircut would likely generate substantial financial stress”. The proposed 21 per cent reduction in the net present value of Greek bond cash-flow translates to much lower reduction in Greek debt.

It’s an interesting argument given that many banks (we shan’t name names) still argue they can absorb even a heavy Greek impairment through retained earnings or existing capital…

On the other hand SocGen does hold out the prospect of increasing the maturities of bonds eligible for the swap, or lowering the coupons that Greece has to pay on the new debt. But they’re very honest about the lack of serious debt reduction this involves, and the restricted nature of some eligible debt, such as the ECB’s bond purchases. We’d argue it’s going to be very hard to sell the bondholders more deckchairs on the Titanic from this point, if they can see the ECB already in the lifeboats.

Anyway — those estimates about the economic damage. SocGen is forecasting a 25 per cent drop in Greek GDP in the first year after official creditors pull the plug, and for the economy to halve in size following a Greek default and departure from the euro. Then there are future declines of up to 10 per cent of GDP per year after the default. These are intense numbers. There has been a spate of similar research however (hello, UBS!).

It’s worth comparing the latest doom-stats to the historical context, even though we know that Greece is going to break almost every record for sovereign defaults. Here’s a chart from a 2006 Bank of England paper about the costs of sovereign defaults from 1970 to 2000:

The paper also points to heavy losses in actual post-default output versus the potential (pre-crisis) rend, and this will especially hold in cases like Greece’s where there won’t just be a default, but a banking crisis and possibly currency change. The paper adds that Argentina’s economy shrank 25 per cent over the course of its triple-dip crisis. Even then SocGen’s estimates stick out.

SocGen’s 50 per cent case is based on Greece leaving the European Union in order to leave the euro. That corresponds to the general consensus on how a euro exit would legally work, and it means Greece loses EU structural funds, agricultural subsidies, access to the single market, and so on. Maybe SocGen’s right: no sovereign default has ever this been interconnected before.

The thing is, the fact that failure would be more or less catastrophic hasn’t ensured success. In fact Greece is now on the brink and further developments will only pull it further in, the more it runs of out of cash. Making failure catastrophic – by increasing the subordination of bondholders to official lenders, thus upping contagion costs as private recoveries hollow out — hasn’t helped either. That’s a lesson for the sovereign risk now lurking behind the EFSF as much as anything else.

And they’re all learning it on the way, and way too late.

Related links:
Disorderly default, almost as bad as civil war – FT Alphaville
Why Greece may soon get a new currency – Street Lights
“Anomic breakdown” (video) – Paul Mason / BBC Newsnight
Greece creditors in bail-out backlash – FT