As Greek government bonds yield lower interest than France’s, the Eurozone faces a critical test over whether European institutions will enforce fiscal rules consistently or protect politically influential member states, says Tim Focas
If someone had told investors during the eurozone debt crisis of 2012 that Greece would one day borrow more cheaply than France, you would have put them in a straitjacket. Yet here we are at the back end of 2026, and French ten-year government bonds are yielding 4.9 per cent, against Greece’s 4.36 per cent. The country once synonymous with sovereign bankruptcy is now being charged less to borrow than one of the European Union’s founding powers. Welcome everyone, roll up roll up, and look to see the Eurozone’s spectacular see through the looking-glass economy.
But an Alice in Wonderland production this certainly is not. For anyone who was unlucky enough to have lived through the Greek debt crisis, this turning of the tables puts a ginormous elephant in the room and begs the question, when the next sovereign debt crisis does hit Europe, whose interests will the EU really protect?
Investors who still have the scars to prove what happened last time will inevitably be asking themselves this question right now. Back in 2012, Greece completely rearranged its government debt, and imposed a 53.5 per cent nominal reduction in the amount of debt owed on private bondholders. Unfortunately, this only masqueraded over the true destruction of investors’ wealth. The remaining 46.5 per cent wasn’t handed back in cash and much came in the form of long-dated, low-interest bonds worth much less than their face value.
Meanwhile, the Eurosystem’s holdings escaped as Greece retrospectively inserted collective-action clauses into bonds issued under Greek law which allowed most creditors to force restructuring terms upon disgruntled investors. To put it another way, the rules were basically rewritten after investors had bought the bonds. At the same time though, the European Central Bank and national central banks had exchanged their eligible Greek bonds for securities outside the restructuring and, as a result, their holdings were protected while private investors absorbed enormous losses. Then, just to make sure everything was watertight, the European Court of Human Rights subsequently accepted that the restructuring interfered with investors’ property rights, but concluded that the interference was justified by the exceptional circumstances and wider public interest. Legally permissible perhaps, but the question that still lingers to this day is was it really equitable?
Political risk
Unlike Greece though, France is the lifeblood of the EU budget and, alongside Germany, is the cornerstone of political power in Brussels. That makes its precarious borrowing position particularly uncomfortable for those passionate about protecting the Eurozone at all costs. Now let’s not get things twisted, France is certainly not Greece if only because it has a much larger and more liquid debt market. Nevertheless, investors shouldn’t forget that sovereign bonds carry huge political as well as credit risk. Staunch ECB’s defenders will of course make the case that protecting central-bank holdings was imperative to prevent financial contagion.
Nobody would dispute this, but at the same time, it doesn’t erase the losses imposed on private creditors. If France’s public finances get worse, would financial institutions across the bloc really tolerate a Greek-style treatment of creditors? Or would we suddenly see a more “flexible” interpretation of Europe’s precious rules-based system when the country that just so happens to have its fiscal feet to the fire is too politically important to make an example out of?
That is the double-standards predicament confronting Europe, which they have no choice but to face head on once again. And, if this wasn’t uncomfortable enough, the yield advantage offered by French bonds over Greek bonds is currently not even one full percentage point. Would any investor in their right mind accept a modest premium of 0.36 per cent in return for all the political uncertainty? With many still licking their wounds from how quickly contractual protections can be overwhelmed by sovereign necessity, surely they would have to think very carefully.
Pricing inflation, interest rates and assessing default probabilities is just what markets naturally do. However, pricing in the likelihood of European institutions tweaking the rules when it politically suits doesn’t come as naturally to investors as Greece taught them at extraordinary cost. With France now firmly in the firing line, we may soon find out whether Europe has learned its lesson.
Tim Focas is head of capital markets at Aspectus Group