Shave and a haircut

The most that can be said about the Eurozone rescue deal that was agreed in Brussels overnight is that it was significantly better than the markets had begun to fear in recent days. There is a lot of detail to be filled in over the coming months, but in principle the deal should buy the Eurozone the time it needs to carry out the reforms that will really put an end to the sovereign debt crisis. The Economist has a good summary and analysis of the deal here.

One of the hardest parts of the deal to finalise turned out to be the scale of the "haircut" that private lenders will have to take on their holdings of Greek debt. At the last Summit to end all Summits, back in July, a figure of 21% was agreed. That never looked to be enough, and now the size of the haircut has been raised to 50%.

Anyone who sees the financial crisis as being entirely the fault of the banks will no doubt be incensed that they tried to fend off the bigger write-off. After all, the loans were made voluntarily, and the fact that Greek bonds paid significantly higher yields than their German equivalents ensured that investors were being compensated for the risk they were taking on.

This is a good principle: you make a bad deal, you swallow the loss. In the normal course, it's up to investors to satisfy themselves about what they are buying, through s process of "due diligence". For purchases of Greek government debt, this would involve analysing Greece's budgetary position and prospects in considerable detail, to ensure that the country would be able to repay its obligations as they fell due.

Simple, right? Except that in this particular case, the lenders have much more of an excuse. We learned many months ago that the Greek government lied about its budgetary situation for years, in order to smooth its path into the Euro. Shouldn't investors and lenders have been able to figure that out? Well, maybe, but in this case Greece's misleading data were being awarded regular seals of approval by the EU authorities. If the latter, with much more complete access to the raw data than the private lenders could ever hope to have, were allowing themselves to be duped, what realistic hope did those lenders ever have of avoiding the trap?

We can't let the entire financial sector of the hook, however. It's been widely reported that Goldman Sachs undertook a fancy structured transaction that helped Greece to conceal the size of its debts, and they weren't the only ones. The banks that put such deals together must have had some knowledge of the real situation, but chose not to spill the beans to their clients. Still, the fact remains that a lot of insurers and fund managers just found themselves being bullied into a 50% haircut by the same Eurozone authorities that lured them into the Greek market in the first place. No wonder it was hard to reach an agreement.

So much for the past. There's also a more forward-looking reason why it was important to get the scale of the debt write-off right. A lot of commentators, especially in the US, have been voicing concerns that if Greece were allowed to walk away from its debts with relatively little pain, a queue of other borrowers would start lining up to demand similar treatment. Write-offs for Greece may be something the global financial system can manage, but if Spain or Italy wanted the same, the pressure on balance sheets could be devastating. The 50% write-off for Greece, while painful for the lenders, still leaves the country facing a mountainous debt and years of austerity. This should guarantee that this is not seen by other debtors as an easy option, but only time will tell if the right balance has been struck.

It's hard to say how much time this latest deal will buy for the Eurozone. Any backsliding on the details over the next few months could see a swift return to crisis mode. But never mind, there may be a diversion on the horizon. The bipartisan super-committee of the US Congress, set up as part of the resolution of the debt ceiling debate, is due to report in late November. There hasn't been much evidence of a meeting of minds, and today S&P fired a warning shot: it's ready to downgrade Uncle Sam again if the promised deficit-cutting measure show signs of falling apart.

Stay tuned! One way or another, 2011 is turning out to be a good year only for those very few who kept in mind the wise words of Polonius to Laertes: "Neither a borrower nor a lender be, For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry".