Haircut necessary, though not ideal

The Greek finance minister may not talk about a haircut, but it is clear that the German proposal for a 50 percent reduction is on the table. The fact is that it could not have been otherwise. Given the instability of the international economy and Greece?s vicious recession cycle, Berlin?s proposal simply confirms what so many experts have been saying from the start: that even in the best-case scenario for the Greek economy, the country?s debt cannot be made sustainable without a radical restructuring.

The first tentative step in this direction was made with the extension of the payback period for the first 110-billion-euro bailout loan and a slight downward adjustment of its rate of interest. The second step was the July 21 agreement signed between Greece and its creditors, which foresees a reduction of the country?s debt by some 20 percent. Neither of these steps, however, sufficed, and this is why the July 21 deal is half dead before it has had a chance to be put into action.

The problem with European policymakers is that they are always one step behind developments, and the longer they delay the haircut, the deeper it will have to eventually be in order to render Greek debt sustainable. Obviously a significant haircut would cause Greek banks and insurance funds to suffer equally significant losses and the state would have no other option but to cover these losses in order to ensure their smooth operation.

We musn?t forget that the term ?haircut? is not a dirty word. It is in the lexicon of the markets and it means that when a private entity lends money, it takes on a certain amount of risk. The level of the interest rate, meanwhile, is proportional to the size of the risk. If it were 100 percent certain that all countries that borrow would be able to pay back in full, there would be no fluctuations in interest rates and every country would borrow on the same terms as Germany. Therefore, creditors and banks that sold high-risk credit default swaps have no right to complain today.

Obviously a haircut alone cannot solve Greece?s problems. It needs to be combined on the one hand with radical fiscal reforms and, on the other, with the development of Greece?s production potential, in order to generate wealth.

In other words, a haircut is necessary, though not ideal.