October 31, 2011
It is hardly surprising that the markets are having second thoughts about last week's euro zone rescue deal. The scale of the relief rally on Thursday was surely prompted by the fact that some deal was done, not by the (sketchy) details of the deal itself.
Take the three aspects of the deal - Greek debt write-down, bank recapitalisation and the boosting of the firepower of the EFSF. On Greece, a 50% writedown of debt is what many people had called for. But this is just a write-down of private sector debt (even then it's not clear whether this can be achieved on a voluntary basis). A lot of Greek debt is now owned by official bodies who are not willing to take a write-down at all. So Greece will still be left with an 120% debt-to-GDP ratio by 2020, a level that looks unsustainable. The word "solution" hardly seems to apply.
Any Greek write-down would hit the banks which is why recapitalisation is needed. But the €106.5 billion being raised is a lot less than others thought necessary (including the IMF). Nor is it clear from whom the money will be raised or whether the capital ratio will be boosted instead by banks shrinking their balance sheets, a development that would be unhelpful for the European economy.