Fisher Investments Editorial Staff
Geopolitics, Market Risks

French History Lessons

By, 06/28/2011

Story Highlights:

  • French President Sarkozy announced Monday a group of French banks would be willing to participate in a Greek financial rescue plan.
  • Germany’s Axel Weber, however, had other thoughts on how to resolve Greece’s debt crisis.
  • Either plan is economically feasible, and progress will likely continue plodding along—which is ultimately fine from the market’s perspective.

If some folks’ gut reaction to any plans proposed by the French government is skepticism, that’s fairly understandable. (Think Maginot Line.) But while the media’s eye has been primarily focused on Greece’s upcoming austerity measure votes, protests and political wrangling, France has stepped up with a proposal to help mitigate Greece’s current debt issues.

French President Nicolas Sarkozy announced Monday a group of French banks would be willing to participate in a financial rescue plan by extending the maturity of 70% of their Greek debt holdings—50% would be reinvested in Greek debt with a 30-year maturity, and the remaining 20% would be invested in a separate guarantee fund. Interestingly, many in the media and across Europe (primarily Germany) have insisted the private sector wouldn’t participate in extending maturities voluntarily without explicit guarantees from authorities like the EU. And up to now, European governments have avoided guaranteeing Greek debt as a sweetener, fearing it could introduce moral hazard—encouraging countries to overspend. But instead of outright guarantees, the French proposal’s separate fund would serve a similar purpose, investing in zero coupon, high-quality government bonds and essentially backstopping repayment of the 30-year bonds. This plan doesn’t remove all potential of a Greek restructuring—but it could help mitigate both impact and urgency.

Former Bundesbank chief (and former ECB second-in-command) Axel Weber, however, has an alternative suggestion: guaranteeing all of Greece’s outstanding debt. Otherwise, Weber suggests, Europe only continues to kick the can down the road and patch what could otherwise be solved with a single step. A fair point, but the French plan theoretically kicks the can so far down the road, it might accomplish a similar end goal. According to Weber, the options are limited at this point: haircuts (i.e., creditors are returned less than their initial investment), default or guaranteeing the entire amount of outstanding debt.

So whose plan to follow? The French plan seems fairly straightforward and contradicts suggestions private banks wouldn’t willingly offer maturity extensions. Yes, it includes a “sweetener” in the sense that part of the yield is essentially tied to Greek economic growth over the next 30 years. But nevertheless, that private banks in a country with one of the largest stakes in Greek debt came up with a plan to ease the Greek burden and help avoid default is a positive sign—and one that could send private banks in other eurozone member countries down a similar path. And to that point, despite periodically insisting private participation be compulsory, Germany’s expressed interest in France’s plan.

On the other hand, Weber’s suggestion that a 100% guarantee of Greek debt is the best solution (in the sense it avoids default or haircuts) is also feasible, economically speaking. There’s undoubtedly sufficient capital among eurozone members and institutions to backstop Greek debt. And doing so seemingly clears up the problem more or less instantaneously—if all outstanding Greek debt is guaranteed, there will be fewer eurozone losers. Granted, such a plan would likely still require some form of Greek austerity or other measures to avoid moral hazard—the temptation for Greece to continue spending knowing the rest of the eurozone’s guaranteeing their debt. And for eurozone creditors, the political cost of such a plan could be sufficiently high to ensure relative hawks like Germany’s Angela Merkel don’t back it.

Either way, progress seems to be coming—albeit slowly. And that’s ok. For markets, a gradual, step-by-step resolution to the Greek debacle is probably preferable—whether the endgame is haircuts, guarantees or other. What Monday’s debate most poignantly highlights is there are myriad options to confront the Greek scenario short of a sudden, disruptive default.

Incidentally, the Maginot Line was designed as a means to isolate France from the threat of German invasion—and it was a miserable failure. This time, the French plan is not to guard its borders, but to reach across them. But don’t mistake this for simple charity—no doubt France would prefer not to extend maturities on debt. However, they also seemingly and rationally prefer that to a sudden, disorderly break-up of their monetary union.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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