Default by any Other Name

Restructuring is a polite term for default and default is the ghoul haunting the European sovereign debt markets. Governments can lend each other money and they do it constantly by buying national debt. Governments cannot compel the private market to finance their debt, they can only entice. However, no amount of return can replace capital lost through restructuring; and restructuring is nothing more than a negotiated default. It is the fear of default that drove Greek two-year rates to over 15% last week, essentially closing the debt markets to the Mediterranean nation. It is this fear of default that the Europeans have struggled for months to allay with three bailout packages. The weekend’s €110 billion three-year rescue package for the first time addressed the obvious fact that Greece will need help for several years as it attempts to bring spending into line with revenues. It has not removed the fear of default.

Angel Merkel, the Chancellor of Germany said on ARD television that its time to learn lessons from the Greek bailout and suggested an “orderly insolvency” as a solution. One would be hard pressed to come up with a better or more obvious way to pressure the remaining European high deficit nations to institute austerity budgeting than to warn their current and future creditors, in public, that default is the next stop.

The German government clearly fears that the Greek bailout is just the first and wants, in the strongest terms, to warn Portugal , Spain , Italy and Ireland from considering the Greek route. German Finance Minister Wolfgang Schaeuble said yesterday “We quite urgently need something for the members of the EMU that we also didn’t have during the banking crisis two years ago. Namely the possibility of a restructuring procedure in the event of looming insolvency that helps prevents systemic contagion risks.” Translation: restructuring can prevent systemic contagion. That is quite untrue. Even if there had been an EU restructuring procedure for Greece , utilizing it would have immediately spread the contagion to Spain , Portugal and others. It is the economic and fiscal facts that determine the credit market response not the admission by the defaulting government. An organized default is still default.