How much for the island of Mykonos? The Mexican standoff between European banks owning Greek debt and Greek taxpayers needs fresh thinking. I'm convinced that the only way out of Europe's financial crisis is for Germany to essentially own Greece.
How did we get here? Start with this: European accounting rules allowed Greek and other sovereign debt to be viewed the same as cash on European bank balance sheets. These bonds count toward a bank's capital base and new loans can be written against them without changing a bank's loan loss reserves.
Given this preferential treatment, and insured against default with good old credit default swaps, way too many increasingly worthless Greek bonds are now stuck inside German and French, and of course Greek, banks. Because of out-of-control government spending and entitlements, some half a trillion of Greek debt, 150% of the country's gross domestic product, is scattered throughout the world.
backed by utilities, railroads, tourism, Ouzo factories and maybe even the islands of Santorini and Mykonos.
Of course Greece wants to default so it can start over again. Who wouldn't? But the Germans won't let them default, as that (and subsequent defaults in Italy, Spain and Portugal) would send virtually every European bank into insolvency. I don't know if these banks are carrying Greek debt at face value—they won't say. But a good bet is the bonds are not marked to market, which today might be 50 cents on the euro. U.S. insurer Aflac has already written down almost $1 billion in losses from sales of European debt. A stress test of Europe's banks is due in July. We'll see who fesses up.
So the Germans push for austerity, a much-needed cutback of pay and benefits and even jobs to the 25% of Greeks who work for the government. (What's a Grecian urn? Way too much!) In response, the Greeks riot.
One hard lesson of the post-Lehman Brothers world is that there is no way Greece will be allowed to default, much as Citibank and Bank of America were not allowed to default at the height of the U.S. financial crisis in 2008. The way I see it, the endgame will be something like the Brady Bonds devised in 1989 by U.S. Treasury Secretary Nicholas Brady to resolve the Latin American debt crisis, but with an equity twist.
Under the Brady Plan, bad sovereign debt was swapped for new U.S. government-backed bonds with various interest-rate structures, making them tradeable and easy to move off of bank balance sheets. Ecuador defaulted but Mexico retired their Brady Bonds by 2003, as did eventually most of the dozen plus other Latin American countries.
Euro-zone finance ministers plan to meet again this Sunday to address the Greek tragedy. But so far the only plan on the table is a doomed one by the French for the voluntary restructuring of sovereign Greek debt. Private buyers are increasingly skeptical of government guarantees and will demand real collateral. Credit default swap derivatives, which merely spread the risk, will no longer do. Some other sweetener will be needed. The solution? Bonds backed by real Greek assets.
In this case, you would convert Greek debt, denominated in euros, into long-term German bonds backed partially by the good faith of the German government but also backed by Greek assets—you know, utilities, railroads, tollways, airports, cellphone services, tourism, Ouzo factories and maybe even the islands of Santorini and Mykonos. If (some say when) the Greeks default, the Germans or new bondholders end up with the assets, much like in a home foreclosure. You don't know what bond buyers will demand until you try to sell them this new debt. Maybe they'll want equity ownership along the way, say, 5% ownership transfer every year for 20 years. It's all up for grabs.
The effect would be that these new bonds could be structured to trade near par or face value today, backed by both a strong Germany and real assets. European banks would be saved. These "Brady Bunds" or "Bund Bonds" or "Merkel Bonds" would freely trade and banks could sell them off to clean up their balance sheet, much as the original Brady Bonds.
The Greeks would have a decade to work things out. Austerity would be brought on slowly but surely, and if there were defaults it would happen quietly with asset transfers along the way to Germany (or hedge funds or China) who would end up owning this new Greek instrument. The new owners would then go in and rationalize each business and fire whom they must to make each enterprise profitable, in private versus public hands. This is an old trick of U.S. manufacturers, sell an old factory to someone else and have new, unknown owners fire the workers.
U.S. Treasury Secretary Tim Geithner is too distracted with our own debt-limit arm wrestling to pull this off. Here's hoping there's someone strong enough in Europe to do for Greece—and by extension the entire euro-zone—what Nicholas Brady did for Latin America.