Greek Haircuts

by Elaine Schwartz    •    Jul 6, 2011    •    750 Views

When people talk about haircuts and Greece, they are no longer referring to the female beauticians that retired at 50 with a generous state pension because their work was “arduous.” Instead, they are discussing the losses, known on Wall Street as “haircuts,” that Greek bondholders might be force to take.

A WSJ column presents 3 default alternatives and 4 key issues.

Default Alternatives:

  1. Selective default: Some bond payments are postponed while others are paid on time.
  2. Organized default: All bondholders take a “haircut” within a predetermined plan.
  3. Disorganized failure: All bondholders take a “haircut” but there is no predetermined structure.

Key Issues

  1. Greek financial obligations: Greece still is living beyond its means. If it defaults, how will it pay wages and provide public services?
  2. Greek banks: Greek’s banks own a lot of Greek bonds. A default would threaten Greece’s entire banking system. (This FT column is excellent.)
  3. European banks: Many euro zone banks that own Greek bonds have not yet recorded their true value on their balance sheets.
  4. Contagion: If Greece defaults, will investors, worried about risk, make borrowing much more expensive for Ireland, Portugal and other financially weaker euro zone countries?

Saying that Greece has been rather forthright about its dire financial straits, NY Times financial journalist Floyd Norris characterizes the lenders who own Greek bonds as the group that is avoiding reality. Their policy? “Delay and pray” or “Extend and pretend.”

Finally, an historical perspective from Harry Truman in 1947. “Should we fail to aid Greece and Turkey in this fateful hour, the effect will be far reaching to the West as well as the East. We must take immediate and resolute action.”

And long before 1947: The first of many times that Greece defaulted on her debt was during the 4th century B.C.

The Economic Lesson

A bond is an IOU, a promise to repay a loan. The value of the bonds Greece has promised to repay is close to 155% of its GDP. Because GDP represents the value of goods and services that the Greek economy produces during 1 year, comparing the 2 provides an idea of whether they are living beyond their means.

An Economic Question: The Greek government plays an active role in the economic life of its country through the salaries and entitlements it pays and the businesses it owns. Do you believe in considerable or minimal government economic intervention?

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