Greek haircut

It is widely known that economic policy is 50 percent psychology. The heated debate on financial aid for Greece is a case in point. The Greek government claims it is already unable to service its debt without the next eight billion euros from the international bailout fund and that it cannot pay civil servants' wages and pensions.

The finance ministers of the other 16 eurozone countries, on the other hand, say that Greece does not need the money until November. New funds will only be delivered if Athens makes more of an effort to save. So, both sides are putting on political pressure, while the actual state of the economy seems to be secondary.

It has been obvious since at least early summer that Greece would not be able to reach its budget deficit target this year. It is therefore a bit of a mystery why the financial markets tanked again when the Greek finance ministry reiterated that fact recently. But that is where psychology comes in again.

Franco-Belgian bank Dexia and other financial institutions holding Greek debt have been under pressure because the markets know what is coming. A haircut for Greece - meaning partial debt relief involving Greece's creditors - is on the cards and the longer the EU waits, the dearer it will get.

Greece is likely to need the haircut by November, which is why the next tranche of the bailout has been delayed. Creditors, like US and European banks, need to be prepared for the haircut, the restructuring of Greece's debt.

The biggest creditor, however, is the European Central Bank, who bought a large part of Greece's bonds from private banks. Of the financial institutions, Greek banks will be hardest hit, as they hold most of the Greek government's debt.

In reality, the efforts of the EU and the IMF to save Greece are essentially about propping up and, ultimately, saving the European banking system.

It is already apparent though that not all banks can be saved. Some, like Dexia most likely, will have to be put into so-called bad banks. Those bad banks will have to be guaranteed by the European Financial Stability Fund (EFSF), and ultimately, by the taxpayer. Which cannot happen until all 17 members have ratified the new EFSF accord. Slovakia and the Netherlands have still not approved the extension of the bailout fund. The Slovakian parliament is expected to do so by October 14, but there is still a possibility that it may not pass. That is another reason why finance ministers are putting things off until November.

EU politicians are playing for time to prepare for the haircut, but it is still unclear what effect the debt restructuring will have on countries like Italy and Spain and their banks. What is obvious though is that things cannot stay as they are.

Debating aid and fresh credit for Greece every three months, like a recurring Greek tragedy, only scares off investors and certainly does not calm the markets. That is why a haircut sooner rather than later is preferable to the seemingly fruitless and endless extension of credit to Athens.

That said, even experts cannot fully predict what effect the debt restructuring will have on the banking system, which is why finance ministers have shied away from it so far.

Decisions will have to be made at the next EU summit on October 17. It simply will not do to just carry on as before. And while European efforts are being coordinated, central banks across the world are already bracing themselves for a new global banking crisis and lending European banks money to boost their liquidity.

The G20 group of leading industrial powers and developing nations is also behind that concept, to avert a global financial crisis. All these efforts are designed to calm the allegedly so sensitive markets, and again, a good deal of it is down to psychology.

Author: Bernd Riegert / ng
Editor: Nancy Isenson