Finally! Germany's Chancellor Angela Merkel has told Germans that she might eventually write-off Greek debt, and that bailing the country out will cost Germans less than letting it default and leave the euro area.
Those two pieces of long overdue candor mark an important step forward and an end to denial. They create a glimmer of light at the end of Greece's bailout tunnel, a prerequisite for confidence to return to euro-area bond markets and for Greeks to start believing that internal devaluation will eventually pay off for them.
Regrettably, Merkel is also sticking to her morality tale on Greece. In an interview with the German newspaper Bild am Sonntag, she ruled out implementing such a writedown until Greece is running a budget surplus. That's good for Germany's chancellor because it won't happen until well after she faces re-election next fall, but not so good for Greece, Spain or Italy. In terms of financial crises, that's a lifetime away.
Until then, it looks like the burden of keeping Greece afloat will fall primarily on Greek banks in a shell game called a debt buyback. To secure its next tranche of bailout funds from the International Monetary Fund, Greece has to successfully repurchase government bonds with a value equivalent to about 11 percent of gross domestic product, from private investors who hold a total of 62 billion euros' worth of the bonds.
Greece on Monday set the terms: It will borrow as much as 10 billion euros ($13 billion) to buy back debt at 34.1 percent of face value. Predictably, that drove up the market price of Greek debt this morning to just over 39 percent of face value.
So who will buy at the lower price? Some hedge funds might sell if they bought at lows of around 15 percent in June. But most likely the lion's share will come from Greek banks and perhaps pension funds, which among them hold about 23 billion euros of debt. The banks have an interest in making sure the buyback succeeds, because the bailout tranche that would follow includes funds for recapitalizing the Greek banks. The net result: The Greek government will borrow from Europe to buy back its debt from Greek banks at bargain prices, and then cover the banks' losses with more money borrowed from Europe.
Let's hope the buyback works and prevents a Greek default for a while longer. But staving off default will not bring a Greek recovery, which requires, among other things, solvent Greek banks that are willing and able to lend to companies. Fixing the Greek banking system will require more drastic action from other euro-area members.
It would be naive to dismiss the realities of electoral politics in Germany. But Merkel should make Sunday's breaking of the writedown taboo just the start in an information campaign aimed at her own electorate. Merkel, her government and her party should ditch the politically easy morality tale of lazy Greeks versus virtuous Germans, and exchange it for transparency on what a Greek default might cost Germany, how German banks (and ultimately taxpayers) benefited from bailouts to date, how German companies benefited from Greek and Italian profligacy, and what the shock of a euro exit might mean for Germany's future relationship with the rest of Europe.
Everything is predicated on Greece implementing the changes to areas such as tax collection and public sector efficiency that the IMF and the European Union have demanded, as it has already slashed wages and pensions. Assuming it does, better-informed taxpayers in the north will be better prepared for a debt writedown after Germany's elections, or even before should that become unavoidable.
(Marc Champion is a member of Bloomberg View's editorial board. Follow him on Twitter.)
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