Henes: A Greek Tragedy in the Making?

Jonathan S. Henes, P.C.|Kirkland HKSCKPVIamp; Ellis LLP
Monday, 30 Jan 2012 | 11:43 AM ET
Jorg Greuel | Getty Images

On March 20th, Greece owes $18.5 billion to its bondholders. It does not have the money to make this payment and, without a bailout from its partners in Europe, Greece will default.

The default will not be “voluntary,” whatever that means; but, rather will be hard, dramatic and real.

CDS will be triggered and the world will watch to observe the repercussions. The chorus is singing that a Greek default will have little or no impact on the markets or other eurozone nations. The argument goes that Greece is tiny and an $18.5 billion default is a fly on the back of an elephant. Maybe so. Or, maybe Europe should listen to a seer and “beware of the Ides of March!”

Now, the Ides of March falls on either March 13th or March 15th, but for Europe, that faithful day may just be March 20th. There are two primary questions: will a default by Greece actually occur? And, if a default occurs, what will happen?

As to the first question, it seems more likely than ever that a default might occur. While the reports coming out of the bond restructuring negotiations between Greece and its private bondholders appear optimistic – the Institute of International Finance, which is negotiating on behalf of private bondholders, emailed that Greece and the bondholders are close to agreeing on a bond-for-bond exchange – Germany made headlines by stating that Greece would only receive a bailout if it “implements the necessary decisions and doesn’t just announce them….”

To be clear, despite all of the headlines about the Greek bond restructuring, it is not the main event. The bond-for-bond exchange would not actually fix anything. It would not avoid a Greek default. What it would do is lower Greece’s interest costs and lessen some of its debt. Does this really matter? Not so much. The stated goal of the restructuring is to reduce Greece’s percentage of public debt to GDP to 120% by 2020. 120% of public debt to GDP also is unsustainable and to even get to that level requires a sizable reduction of debt (more than currently contemplated) and an increase in GDP (which does not happen without economic growth).

So, on to the main event.

The only way for Greece to avoid a default on March 20th is to receive a bailout.

To receive a bail out, Germany will require Greece to implement additional austerity measures – which may include the termination of more than 100,000 public sector jobs. There are two problems with this concept. First, austerity – raising taxes and cutting spending – leads to economic decline. This will negatively impact Greece’s GDP and increase its public debt to GDP ratio, thereby negating any perceived benefit of a bond-for-bond exchange. Second, and perhaps more important, at some point Greece will declare that it has had enough. How much pain can Greek politicians inflict on the Greek people – especially when the decisions are being forced by other members of the eurozone. Consequently, if further austerity measures are a condition to a Greek bailout, we might just see a default on March 20th.

Does any of this really matter? Of course. But, truthfully, no one really knows how much. Greece is small and an $18.5 billion default is not large in the context of Europe as a whole. But beware of the law of unintended consequences. We should all remember the days before Lehman filed for bankruptcy. The chorus sang that Lehman should not receive a bailout. The chorus warned that a bailout would cause moral hazard and comforted that the ramifications of a Lehman failure would not be so bad. But the chorus was wrong. The markets collapsed and the economy went into a tailspin. Would the same happen as a result of a Greek default? No one knows. But we know there will be ripple effects. The current chorus sings that they won’t be large. We’ve seen the chorus wrong before. Beware of the Ides of March.

Jon Henes is a partner in the restructuring group at Kirkland & Ellis LLP where he has led some of the most complex restructurings in a variety of industries, including media, chemicals, energy, manufacturing, real estate, retail and telecommunications. Jon has also frequently appeared on CNBC's "Worldwide Exchange" as a guest expert on various financial and economic topics and is a member of the Economic Club of New York.