Greek Restructuring Fears Spook Markets

With the slip of the tongue, German Finance Minister Wolfgang Schaeuble managed to spook the markets late last week. In an interview with a German newspaper, Schaeuble talked about Greece debt situation and hinted that Greece, the first euro zone country to get bailed out, may have to restructure its debt!

Apparently, Schaeuble said that if all the whiz kids at the EU and IMF do their number crunching and see that Greece’ debt level is unsustainable, then Greece may have no choice but to restructure its debt. Take note that until the European Stability Mechanism (ESM) begins in 2013, Greece cannot take any losses on its debt.

Schaeuble swears that his words were misinterpreted, but I got news for you Wolfy – once the markets hear bad news, they jump on it like it’s a Benjie in the middle of the road!

Following the release of the interview, bond yields soared, as 10-year Greek bond yields were well above 13%. This sent the yield spread on comparable 10-year German bonds to more than 10%! Meanwhile, premiums for credit-default swaps (basically insurance in case of a sovereign debt default) on Greek debt hit all-time highs, reflecting the increased skepticism that Greece can repay its debt.

As you can see, the restructuring is a serious issue. But the question is, why?

First, lemme explain what debt restructuring is. In its simplest form, a country seeking to restructure its debt will negotiate for a reduction in its current debt payments and aim to pay back the debt over a longer time period. This gives the country more time to get in better financial shape so that it can pay back the total debt later on.

The reason why the markets get uneasy when the possibility of restructuring is brought up is because Greece isn’t the only country with debt concerns in the euro zone. With Portugal already asking for a bailout and speculation that Spain may be next, any news about restructuring could spark another round of contagion fears.

Furthermore, if these fears continue to weigh on the markets, it will cause yield spreads to widen further, making it even more expensive for Greece to pay off its debt, putting the country in a vicious cycle.

The good news is that if you listen to the Greek government’s two Georges – Prime Minister George Papanderou and Finance Minister George Papaconstantinou – Greece is hell bent on avoiding that scenario.

Late last Friday, the government released details of the austerity measures it plans to implement in order to get its debt under control. Through a 76 billion EUR program that will include a series of deficit cuts and government assets (e.g. government owned telecommunications and power companies), the Greek government hopes to bring down its budget deficit of 13.6% of GDP in 2009 to just 1% of GDP by 2015.

I must commend Papanderou though, as he recognizes that asking for debt restructuring is NOT the way to get things done. In response to all the recent speculation, Papanderou said that Greece’s problem wouldn’t go away by restructuring its debt, but by restructuring the country. Amen Big George!

With results of the EU and IMF study coming out in June, look for the Georges to try and build up support for the planned austerity measures. In the meantime, keep your eyes and ears open, cause you never know when someone will say something to rock the markets!