The Latest EU-Greek Bailout and Liquidity Risk

Treat liquidity risk and runs on institutions as fundamentally a question of lack of information – the lack of information on the underlying financial solvency prompting flight from uncertainty.  In that case, the question following the announcement in the press yesterday of the Greek-EU bailout is not so much what it signals about liquidity, as instead what contribution it will make toward the forward discovery of Greek solvency – if any.

As many observed, in this announced deal, there is a fixed amount of money committed, rather than vague political promises.  At some 30 billion euros, plus additional commitments from the IMF, yes, of course, the effect of the announcement eases immediate liquidity fears.  What remains is what the breathing space will do to fill in the missing information about Greece’s underlying solvency.  As the WSJ’s Richard Barley says in today’s Heard on the Street:

Even the clearest, most credible part of the deal—the interest-rate mechanism—raises questions. On one level, a 5% rate for a three-year fixed-rate loan represents a concession relative to last week’s market levels. But this is still 3.7 percentage points over three-year German debt—a long way north of where the Greeks would like to be able to borrow. Indeed, if Greece were to take a 10-year loan under the package, it would be at a rate of well over 7%—the rate the market would have charged last week.

In a curious way, this may act as a floor to private-market rates. Why should a bond investor lend money more cheaply than other euro-zone governments are willing to do? After all, two-year yields on Greek debt, while down sharply from last week, are still 5.47%.

But the uncertainties over solvency in the longer term remain broadly political.  Barley goes on to discuss the political issues of contributions by EU governments – including Spain, Ireland, and others also under pressure.  But perhaps the greatest solvency uncertainty, and one which is not necessarily helped toward price discovery by means of the liquidity breathing space offered by the current funds, is whether Greece will be able to do anything near to what it has promised in the way of internal fiscal reform.

It is not a matter of an injection of liquidity, in other words, for the purpose of allowing for outsiders time to find out the “true condition” of the balance sheet of an institution.  It is far more for the purpose of allowing outsiders to assess the ability of the government to reform that already whacked-out balance sheet.  The immediate bailout funds will not last long enough to see a convincing answer to that question over the future which it necessarily entails.  So outsiders will be making an assessment of political risk into the future.  Will they believe the Greek government and Greek society?  Should anyone?

The wonder, frankly, is that news stories over the weekend were suddenly talking about Greek solvency, as though it had ever been anything other than the fundamental question.  Barley’s last point is particularly interesting – he calls for a mechanism for sovereign debt restructuring specific to the Eurozone:

The need may yet arise for a mechanism for an orderly restructuring of sovereign debt within the euro zone. Ultimately, this could strengthen the euro as an institution. Policy makers should use the time that Sunday’s deal has bought to work out what they would do if it doesn’t solve the problem—and Greece ends up following in the footsteps of Argentina, which defaulted after a decade of IMF bailouts.

(I’d be very interested to know what my favorite scholar of sovereign debt restructuring, WCL’s own Anna Gelpern, thinks about that possibility, or perhaps hear from her co-author, Mitu Gulati!  Is there any sense to talking about a specifically euro-zone sovereign debt restructuring mechanism or authority?)