High Noon Approaching for Greece?

The Greek tragedy in several acts would appear to be approaching a climactic moment. The warnings coming out of Berlin all week have been hard to ignore: "Greece either puts up or shoves off" would seem to be the blunt message being offered.

Only yesterday, German Finance Minsister Wolfgang Schaeuble informed members of the parliamentary budget committee that Greece is now perched on a "knife's edge". This follows hints from other leading German politicians (including Angela Merkel herself) that a Greek euro exit is no longer the unthinkable taboo topic which it had been to date. If Greece does not meet the conditions it agreed to, as assessed by monitors from the International Monetary Fund, European Central Bank and European Commission, then payments will stop, Wolfgang Schäuble told listners to Deutschlandfunk radio during an interview today. “Then Greece has to see how it gets access to financial markets without help from the euro zone,” he said. “That’s Greece’s problem.” Mr. Schäuble did point out, however, that at present there is no legal mechanism to expel a country from the euro area.

The fact that an expulsion mechanism doesn't presently exist doesn't mean one couldn't be created, and this was a possibility which the Dutch Prime Minister Mark Rutte explicitly advocated this week in an article in the Financial Times.

The backdrop to all this heavy language is, of course, the sudden suspension of the quarterly program review by Troika representatives at the end of last week. The message that is being put across to the Greek administration is that they need to come up with the goods by next Monday when discussions on their review are set to resume—or else. Naturally, the easiest thing to assume is that all of this is simply a bout of strong rhetoric to try and force the Greek government to fall into line.

But there is another issue looming which could also threaten to upset the apple cart if the ball bounces the wrong way, and that it the proposed bond swap that constitutes the core of the private sector involvement (PSI) included in Greece's second bailout program at Angela Merkel's insistence. One of the little-discussed features of this swap, which involves some 135 billion euros in Greek debt, is the effect it will have on the legal framework governing Greek bonds. At the present time, some 90 percent of those bonds are governed by Greek law, a state of affairs which would evidently give the Greek authorities a certain advantage were there ever to be a hard default.

As veteran debt lawyer (and current adviser to the Greek government) Lee Buchheit put it in a 2010 paper on Greek debt restructuring: “No other debtor country in modern history has been in a position significantly to affect outcome of a sovereign debt restructuring by changing some feature of the law by which the vast majority of the instruments are governed.” Given this, it's hard to understand why anyone in such a uniquely favorable position and facing the possibility, nay the probability, of a hard landing would wish to voluntarily surrender it.

Yet this is just what will happen if the PSI bond swap goes ahead, since the new bonds will be issued under international and not Greek law. All of this explains why I personally was not that surprised by today's statement from OECD Chief Economist Pier Carlo Padoan that the plan wasn't working out as planned, since there had only been a 75 percent take-up. The Greek government itself raised more than an eyebrow or two when it laid down a minimum 90 percent participation as its condition for proceeding, in a letter the government sent to global finance ministers at the end of August. In theory the deadline for responding was to be tomorrow (9 September) but such is the disorder now reigning in Athens, and even in the headquarters of the National Debt Office, that even this is no longer clear. According to one report early today from Reuters Greece correspondent delays in the Asian roadshow meant the acceptance date would be put back, but then later in the afternoon the same correspondent came out with this story, which clearly suggests that the intention is to maintain the timetable, even though only 70% of bondholders are thought to have responded positively: "September 9 is the cutoff date and it is very likely that we may have a bigger response rate as bond holders rush on the last day," a source close to the procedure is quoted as saying on condition of anonymity.

If the PSI falls, then so does the second bailout plan, and judging by the prevailing mood in Northern Europe at the moment, it seems unlikely that all parties are in the frame of mind to go all the way back to the drawing board. So when the Troika inspectors are on their flights back to Athens, it isn't hard to imagine that they will have more than the fiscal slippage implied by Greece's second-quarter 7.3 percent drop in GDP on their minds.

The above is an ammended version of a post which originally appeared on the CNBC blog.