By Jack Duffy

PARIS (MNI)- Is it time for the European Central Bank to make a
gesture on Greek debt?

As the Athens debt restructuring talks drag on, it has become clear
that major players in the drama, from International Monetary Fund
Managing Director Christine Lagarde to private bondholders led by
Charles Dallara, think it is.

The problem is that whether the ECB takes the same haircut as other
investors or demands to be paid in full, there will be negative
consequences.

An ECB decision not to participate in the debt swap, for example,
would represent an important shift in the way reschedulings have
traditionally been done.

According to Gabriel Sterne, a former Bank of England and IMF
official who is now with the London-based firm Exotix, there have been
roughly 90 sovereign debt reschedulings since the first Paris Club
restructuring deal in 1956. All have applied the principle of equal
burden sharing among creditors, with the exception of multilateral
lenders like the International Monetary Fund and the World Bank.

An ECB decision not to participate in the Greek restructuring,
would severely damage this “best practices” principle, Sterne says.

More important would be the impact this decision would have on
other cash-strapped Eurozone countries. If the ECB treats itself as a
senior creditor not subject to any future debt reshedulings, the more
debt it buys through its Securities Market Program, the bigger the
potential haircut for private investors.

Perhaps that is why as the Greek debt talks have dragged on,
Portugal’s 5-year credit default swaps have rocketed to record levels
and spreads between Portuguese and German 10-year bonds have also
climbed to new peaks. Lisbon’s 2-year notes yielded 16.5% on Friday.

A decision by the ECB to participate in the Greek deal would also
bring problems, however. The ECB is believed to hold Greek bonds with a
nominal value of roughly E55 billion that it purchased in 2010 at around
70 cents on the euro. A 50% haircut would produce billions in losses
that could be considered to be financing of sovereign debt and thus a
violation of the ECB’s charter.

An acknowledgement that it is subject to the same losses as other
investors might also raise questions about what else is on the ECB
balance sheet that needs to be written down. ECB losses would also bring
howls of protest from German politicians already opposed to the SMP and
worried that the next step would be a recapitalization of the central
bank financed largely by German taxpayers.

The IMF, for its part, is sticking to its rule book, which says
that it should only lend if “a rigorous and systematic analysis
indicates that there is a high probability that the member’s public
sector debt is sustainable in the medium term.”

For Greece, it clearly isn’t. So if private creditors refuse to
budge and the ECB stays aloof, then IMF funds stop and Greece defaults
on March 20 when a E14.4 billion redemption is due.

To break the deadlock, many believe that the time has come for the
ECB to make a gesture. A possible gesture suggested by Sterne in a
recent research note would be for the ECB to simply write down the value
of its Greek bonds to the level at which it purchased them.

Thus if the ECB spent E40 billion buying Greek bonds with a face
value of E55 billion, such a writedown would be a E15 billion
contribution toward making Greece’s debt sustainable. It would also show
a committment to the principle of burden sharing while avoiding a hit to
its credibility that taking a loss might cause.

Of course such a solution would still carry the risk of making the
ECB a senior creditor vis a vis the private sector, since the central
bank would be taking a smaller haircut. But the benefit — breaking the
Greek logjam — might outweigh that pitfall. It is also possible that in
return for such a gesture from the ECB, the private investors might be
willing to accept a lower coupon on their newly-restructured Greek
bonds.

But the coupon is really a secondary issue, Sterne said in a
telephone interview. “The stakes are incredibly high and what really
matters is whether the ECB joins in.”

–Paris newsroom, +33142715540; jduffy@marketnews.com

(**EuroView is an occasional column writter by Market News International
editorial staff. Any views expressed are solely those of the writer.)

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