05/27/2011 05:15 PM

Consequences of Debt Restructuring

What Would a Greek Haircut Mean for Germany?


It's the worst-case scenario: Greece no longer able to get loans, with creditors having to wave goodbye to a chunk of their money. But what would it mean for Germany? Would the state have to bail out the banks again, and would private investors also suffer badly? SPIEGEL ONLINE takes a look at the likely consequences.

It may only be a small passage in the statutes of the International Monetary Fund (IMF), but it is the bottom line: An organization can lend money to a country only if it is certain the state will remain solvent for at least one year. Washington experts are increasingly doubtful that this minimum requirement can be guaranteed in the case of Greece.

The heavily-indebted state is due to receive a further tranche of its €110 billion bailout package -- one-third of which is provided by the IMF, with the other two-thirds coming from the European Union -- at the end of June. But if the Greek austerity and privatization measures do not meet the IMF's requirements, with the result that the fund decides not to release the payment, Greece could face the prospect of default.

Whether the euro-zone countries would take over the IMF's share in such a scenario is unclear. Which is why Greece's European partners are probably not too unhappy about the IMF's doubts. They function as a warning signal for Greece that the chips are down: Time to stop playing around.

In any case, the situation has led to another grim scenario, one which has been discussed on the financial markets for weeks, becoming more likely: Greece has so much debt that the state is hardly likely to ever be able to fully repay the money to its foreign creditors. Most, if not all, now accept that some form of debt restructuring will be necessary, and that this could involve reductions of up to half of Greece's debt.

Manageable Consequences

A debt reduction -- known as a "haircut" -- of as much as 50 percent would be an expensive proposition for Greece's creditors. With around €330 billion ($467 billion) in loans, that would mean cutting as much as €165 billion. Most of Greece's debt is with foreign creditors, and so foreign banks and governments would have to take massive hits over the loans Athens is unable to repay in full.

But what would this mean in reality for Germany?

  • Would banks go bankrupt?
  • Would insurance companies have to write off billions?
  • Would fund investors face drastic losses?
  • The answer to all of these questions is reassuring -- at least at first glance. The consequences of a debt write-off against the government in Athens would be manageable for Germany. At the moment, some €25 billion in Greek debt is held by Germany's commercial banks and the so-called "bad banks" set up to take on toxic assets. This debt takes the form of either Greek sovereign bonds in their portfolios or loans made to the Greek government.

    Greece's biggest creditor in Germany is the government-owned KfW development bank. So far, the government's all-purpose bank for urgently-needed cash injections has approved loans worth €8.4 billion to Athens, which were paid out as part of the European and IMF rescue package. Since Germany's federal government acted as the loans' guarantor, the finance minister would have to make up for any shortfalls. If Greece gets a 50 percent haircut on its loans, that would cost the ministry more than €4 billion.

    With €7.4 billion in loans to Athens, FMS Wertmanagement is the second-largest German creditor to the Greek government. But behind the reassuring name -- "Wertmanagement" can be translated as "value management" -- is the bad bank for Hypo Real Estate, which had to be nationalized during the financial crisis. Similarly, the bad bank for Düsseldorf-based regional bank WestLB -- which bears the not overly trust-inspiring name "Erste Abwicklungsanstalt" ("primary liquidation establishment") -- also holds roughly €1.4 billion in Greek sovereign bonds.

    With a 50-percent haircut, the two bad banks would lose around €4.4 billion in total. Taxpayers would end up indirectly footing the bill.

    Sufficient Capital to Avoid Trouble

    The rest of Germany's regional banks, which are known as Landesbanken and are predominantly owned by individual federal states and savings banks, collectively have about €2.5 billion in outstanding loans to the Greek government. But none of the institutions, however, would be left seriously in trouble by a drastic haircut -- they have sufficient capital at their disposal.

    Of mild comfort is the fact that the state would probably not have to come to the rescue of any private institutions. Commerzbank, Deutsche Bank and the DZ Bank, which acts as the central bank for Germany's roughly 1,200 partly state-owned co-operative banks, are (once again) in a position to be able to cope with possible shortfalls by themselves.

    This is aided by the fact that the write-offs at places like Deutsche Bank might be smaller than the amount involved (€1.6 billion) would suggest. Sources close to Germany's largest bank have indicated that the bulk of the Greek securities have already been accordingly revalued. Even if worst comes to worst, any additional reduction in value would tend to be limited.

    The situation would also be manageable for German insurance companies. A year ago, the industry assumed that up to 1 percent of all its investments were in Greek government securities. But since then, the figure is estimated to have fallen well below 0.5 percent, which corresponds to a maximum value of €6 billion.

    A debt restructuring of 50 percent would therefore see write-offs of at most €3 billion. In view of insurance companies' total investments of €1.2 trillion, it is probable that no single company would find itself in serious trouble -- and almost no individual customer would feel the consequences in their life or pension insurance policies.

    Fund Investors have Little to Fear

    Fund investors also have little to fear. With the four largest providers, which manage more than two-thirds of the money, the risks are minimal to non-existent:

  • DWS invested less than 1 percent of its assets in Greece. The value of most of this has already been adjusted.
  • Deka only has one fund which still holds Greek government securities. Even in this product, they do not play any significant role.
  • At Union Investment, the share of total assets held in the form of Greek government bonds is very low, at below 0.15 percent.
  • Of the big four, Allianz Global Investors took the most thorough approach to dealing with the issue. Today, the asset-management firm no longer holds even a single cent in Greek debt.
  • A drastic restructuring of Greek debt would therefore lead neither to a collapse of private banks nor to the implosion of the insurance sector in Germany, and would scarcely affect the fund investors.

    Risk to Taxpayers

    But the situation looks different for the German government and the federal states. At the very least, the large exposure of KfW and the bad banks of Hypo Real Estate and WestLB could end up being expensive. Taxpayers might need to step in, as might the savings banks that are owned by municipalities.

    In addition, the European Central Bank (ECB) has bought up tens of billions of euros of Greek sovereign bonds. Because the Bundesbank, Germany's central bank, holds more than a quarter of the ECB's capital, it would have to take its share of losses accordingly.

    So nothing to worry about, then? Not quite, even if a debt haircut for Greece would appear to be manageable for Germany. The greatest dangers of such a course of action lurk elsewhere. The Greek banking system would probably break down, while the country would find itself unable to borrow on the financial markets for a long time.

    And a partial Greek default could also result in an aggravation of the euro crisis for a different reason. If Ireland and Portugal were to be infected by the debt restructuring virus, the situation would quickly spin out of control. In that event, private banks, insurance companies and investors in Germany would definitely feel the consequences.


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