COLUMN-Euro debt and the high cost of justice: James Saft

(James Saft is a Reuters columnist. The opinions expressed
are his own)

By James Saft

HUNTSVILLE, Alabama, March 31 (Reuters) – It looks just
about possible that creditors are going to be paying something
like their share of the euro zone debt disaster after all.

This could be a little patch of justice in an unfair world,
but like most justice it promises long term benefits but short
term pain, both for those dispensing and receiving it.

Firstly, people with money and a choice are going to –
indeed already are – voting with their feet, choosing not to
lend to the ailing governments on Europe’s periphery.

Secondly some of these creditors to Ireland, Greece and
Portugal and their banks will very likely find that their share
of the damage exceeds their capital, an inconvenient reality
for both the banks involved and the sovereign hosts who will
have to pick up the pieces.

The EU summit last week ended with a set of policies that
told creditors directly that their heads will be on the block
when the European Stability Mechanism (ESM), a bailout conduit,
kicks in.

All European government bonds issued from July 2013 will
include a provision that makes buyers vulnerable to forced
extensions of the bonds, reductions in interest rates and
ultimately write downs of principle in the event of a crisis.

On top of that, once the ESM takes effect garden variety
lenders like banks and pension funds will be subordinated,
meaning the government bailout fund gets its money back first.

Accessing the fund may require a debt restructuring, a
polite term for a partial default.

While this may be just, and is definitely politically
expedient for the politicians trying to sell the bailout back
in Berlin and Paris, it is also the equivalent of ringing a
great big fire alarm in a crowded theatre – everyone is going
to head for the exits.

And they duly have. Ratings agency Standard & Poor’s has
downgraded Portugal and Greece, citing the new rules this week.
There is every reason to expect that Ireland will not be far

Credit spreads have widened in a self-reinforcing spiral
that makes accessing emergency help more likely, which in
itself is cause for yet more selling of government bonds.

Don’t get me wrong. People who have lent money in a cynical
attempt to cash in on the moral hazard trade deserve their
losses, as do earlier lenders who merely failed to do their due

That said, I can’t help but feel this is going to spin out
of the orbit of burden sharing and into something a bit more
chaotic. For me, as for many German taxpayers, this is looking
like a “be careful what you wish for” moment.


Shortly after this column is published, Ireland will
release the results of its new stress tests on its cratering
banking sector. At the same time, if news reports are correct,
an indefinite term bailout vehicle for them with ECB and EU
support will also be announced.

The stress tests will likely show that Irish banks need an
additional 30 billion euros or so of capital, taking Irish
state investment to 75 billion or so, a whopping 45 percent of
annual gross national product.

This is a staggering amount, and given that the policies of
austerity will only erode the value of the assets Irish banks
have lent against further, there is no guarantee that this is
where it ends.

Ireland’s new government appears to be taking a harder line
about forcing lenders to Irish banks to take a portion of the
losses. Subordinated creditors are sure to have their loans
restructured and senior creditors may well face losses too.

To be clear, it is right that the banks that fed the Irish
banking beast with easy loans take losses as a means of easing
the hardships that are falling on the Irish people. Ireland’s
banking system, like Iceland’s and arguably Britain’s, was way
out of proportion to the size of its economy.

This may well be simply a negotiating ploy by the Irish
government, as a substantial write down of Irish bank debts
will spread losses, and more importantly fear, widely across
Europe’s banking system.

A rescheduling by Ireland, Greece or Portugal will be
highly disruptive for global markets, and you can bet that the
ECB and EU are under tremendous pressure to make sure it does
not happen.

There is, though, a sense that there is not political will
or capacity to bring about a solution that keeps Greece,
Ireland and Portugal all on board but can also be sold to the
German electorate.

It has been a long first three months of the year. Egypt,
Japan, and Libya have distracted attention, while the
long-running and procedural nature of the euro zone’s problems
make them a pleasure to ignore.

Things could, in the next week, move rapidly, and perhaps
upend widespread expectations of an ECB hike on April 7.

(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. For
previous columns by James Saft, click on [SAFT/])

COLUMN-Euro debt and the high cost of justice: James Saft