An alternative for Greece

Three years ago I led an ASI team to compete for the Wolfson prize on leaving the Euro in an orderly manner. We got “close but no cigar”, hearing informally that we made it into the top dozen out of over 600 entries. The current position is more chaotic than anything imagined at the time of the competition, with several overlapping institutional problems.

• The Greeks need relief and devaluation. Neither is possible under the Eurosystem which they also say they want. They are going to have to choose. Meanwhile, it is unrealistic to expect Tsipras or any Greek government to reverse 170 years of political dysfunction and collect income taxes from tomorrow morning. They can, however, place asset sales with an outside body and (more or less) collect VAT.
• The Eurogroup (to simplify divergent inclinations) wants to keep the Euro immaculate, that is free of defection or conspicuous violations of its own rules, where they’re fast running out of wiggle room. Policy-makers also fear that further concessions will inflame populism in the other PIIGS, especially Spain where Podemos is leading the pack into the autumn elections. All in all, these objectives contradict each other, leaving the Eurogroup rudderless.
• The ECB and other official European creditors fear a “haircut” (reduction) on the “principal” (headline sum borrowed). This couldn’t be airbrushed off their balance sheets - unlike grace periods, reduced “coupons” (interest payments), extended payment periods and so on. This makes it hard for creditors to take a lead.
• For much of the Greek crisis, the IMF has given the impression of dancing to the ECB’s tune. At long last, it now seems to be manning up – none too soon, as it has risked its standing in the face of future defaults in “sovereigns” (state issued debt). It still needs to establish clear policy distance from the Bank, which should be taken to have relinquished its standing as an official creditor by “enabling” (as they say in AA) a defaulter.

This adds up to a catastrophic failure of leadership. Thus the following proposal, an exchange instrument which enables the IMF to take back the lead it should never have relinquished, grants Greece relief, and spares the creditors the worst by giving them a share in recovery.

1. First, the IMF must reinforce its recent shows of independence, seeing off the ECB’s claim of pari passu priority as an official creditor. It must insist that the Bank joins with other creditors in a 50% plus haircut on the nominal value of its holdings of Greek debt or “old paper”. The Greeks themselves have spoken of 30%, following the Fund last week. This is unlikely to be enough for medium-term sustainability. There may also be some malarkey as between private and official creditors. The pain for official balance sheets is less than the nominal haircut as they bought much of their holdings at market discounts; it will be also abated by (4).
2. Old paper is to be swapped for an exchange instrument or “new paper” with a nominal value reflecting the haircut. This is to be denominated in hard currency, unregistered and negotiable at par for tax payments to the Greek Government. This makes for a liquid secondary market and sets a floor for the value.
3. New paper is to be undefeased (guaranteed by a third party); but is part-collateralised by (and part-redeemed by the proceeds of) early sales of Greek publicly owned assets under the control of a body answering to creditors. No guarantor is available for defeasement, with the US Treasury uninvolved and the ECB compromised. The asset sales would be the €51bn identified in 2010, of which less than €5bn has been realised; and would underwrite between one quarter and one third of the new paper.
4. The coupon is to vary with increases in (and defrayed by a first call upon) VAT receipts above a threshold. This follows the precedent of the Paris Club (ie, for private holders of defaulted sovereigns); guarantees the coupon and offers upside to those taking the new paper.

This proposal enables the IMF to resume its proper role after sovereign defaults, that is leading the workouts. It also gives Greece and its people the breathing space they need and helps out the country’s creditors with a share in the improvement in Greece’s economy.