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13 October 2011 By Neil Unmack

Euro zone leaders may be trying to tweak the Greek debt swap to impose marginally deeper losses on private creditors than agreed in July. That wouldn’t help Greece much, but it would stagger the pain for banks, and Greece’s public creditors.

Greece’s creditors originally agreed to a 21 percent haircut on their bonds, in the 135 billion euro swap agreed as part of the country’s second bailout. Euro zone officials are now contemplating a 30-to-50 percent haircut, officials told Reuters. But part of that would simply come from changing market conditions, suggesting banks may simply use a higher discount rate to value the new securities they would get in exchange for their bonds. In other words, the larger apparent haircut could be more of an accounting trick than a way to lighten Greece’s debt load.

The swap agreed in July used a below-market discount rate of 9 percent to value coupons on the new 30-year bonds. But yields for 30-year Greek debt have risen since July to 17 percent. Twiddle the discount rate to 15 percent, and banks losses jump to 39 percent, even though the terms of the deal haven’t changed.

Greece’s budget deficit this year will be larger than forecast in July, largely because austerity is biting hard. The swap may also need tweaking to lighten Greece’s interest costs and cut the deficit. Cutting the interest rate offered to creditors by a full two percentage points – to 2 percent – would be a step in the right direction, increasing the haircut to some 52 percent.

But Europe seems to be hesitating to go that far. There may be advantages to a more gentle approach for both banks and politicians. Banks would stagger losses over time, taking some pain now and some later. And they would preserve the benefits of the July swap, which protects their principal by getting Greece to collateralise the new bonds with risk-free securities; this means lower losses in the future restructuring.

Euro zone governments can argue they have extracted more from bondholders, and delay the day when they have to take losses on their own loans to Greece. Moreover, Athens would still be slaving under a heavy debt load, keeping it under pressure to reform. But Europe’s leaders should understand that the risk of the crisis dragging on, or even getting worse increases if the debt problem isn’t tackled for good now.


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