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Analysis
Euro area risk-sharing is a reality

Euro area risk-sharing is a reality

Over Greece, much taxpayers’ money is at stake 

by Marcello Minenna and Edoardo Reviglio

Wed 25 Feb 2015

Changes in Greece’s external debt profile underscore how European Union risk-sharing is a reality. In the last five years, Greece’s creditors have effectively mutualised over two-thirds of Greek public debt by transferring €140bn to the European Financial Stability Facility (the sovereign bail-out fund), more than €50bn to the Greek Loan Facility (the bilateral loan account between euro area governments and Greece) and almost €30bn to the European Central Bank’s balance sheet.

In early 2010 Greek government debt was €330bn, around 150% of GDP.  Now it is around €320bn, around 180% of a much-shrunken GDP figure. This is in spite of the biggest sovereign debt write-off in history in early 2012.

Risk-sharing has happened even though it was apparently opposed by major euro member states. The reason is that, in 2010-11, French and German banks (and their governments, which feared they might have to make good their losses) were eager to deleverage Greek risk. Transferring exposures to the euro members was the best way to sidestep this eventuality.

The first step came in 2010 when a bail-out loan from the European Union, the International Monetary Fund and the ECB was used to repay the banks. The second step was the so-called ‘private sector involvement’ of March 2012, involving a debt swap and consequent buy-back of Greek sovereign bonds held by banks and investors, cutting around half their value. This imposed losses, mostly on Greek banks, of more than €70bn. 

Before May 2010 the Italian banking system was barely exposed to Greece, with loans outstanding of less than €2bn. Today the Italian government has exposure of almost €40bn through the EFSF, GLF and the ECB. Spain has gone from exposure of €1bn (held by its banks) to a government position of €25bn. Conversely, French and German banks at the end of 2009 held about 40% of total Greek debt; by early 2012 this exposure had been almost completely unwound, at the expense of their governments.

We have seen similar shifts through the IMF’s involvement. Its loans to Greece amount to €44bn. This has been accompanied by US and UK banks’ complete exit from Greek exposure.

In 2010 most Greek public debt was regulated by domestic law, giving the Greek government discretionary power to curtail the value of debt and damage bondholders. Today Greek public debt is almost completely under foreign law. Even in the extreme scenario of a Greek exit from the euro, the government would not be allowed to mitigate the debt burden by simply repaying bondholders with newly devalued drachmas. Default would be the more likely option. Empirical studies on debt restructuring in different countries over the last century indicate that, whenever foreign law debt exceeds 70% of GDP, default is normally the way out.

Alexis Tsipras, the Greek prime minister, is asking for extra time to avoid default. He wants to make the ECB’s bond holdings ‘perpetual’ and link EFSF loan repayments to Greek GDP. The aim is to reset interest payments to a minimum, supported by €5bn annually from the primary budget surplus, which would allow the Syriza-led government to enact the political programme on which it was elected.  

Greece’s partners have a strong interest in giving Athens more time. If Greece defaulted, the EFSF would be the first to collapse.  All member states would record EFSF losses as well as their own. This would add €25bn and €20bn respectively to public debt burdens in Germany and Italy.

To prepare for this eventuality, German risk strategists ensured that the ECB’s quantitative easing programme announced last month included the purchase of about €100bn of EFSF securities. If the EFSF collapses, there are resources behind it – and they stem from the ECB. All this explains why European governments are anxious that Greece remains in monetary union. If Athens is financially ruined, a lot of taxpayers’ money will be burnt too.

Marcello Minenna is Adjunct Professor at the Finance Department, Bocconi University, Milan, and Edoardo Reviglio is Adjunct Professor at the Department of Business and Management, LUISS Guido Carli, Rome.

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