The protracted struggle over Greek debt restructuring – which seemed further than ever from resolution at the end of last week – feels like an argument in a restaurant. The food has been eaten, but the diners don't agree about how much they each consumed. And everyone around the table has an interest in minimising their share of the bill.
The intransigence of various hedge funds, which apparently see no downside in holding out for a large profit on their speculative acquisitions of cheap Greek debt, has, understandably, captured most attention. Their behaviour is unlikely to have shifted the opinion of European politicians, who have long regarded these investment funds as financial locusts. But there's another diner with a large appetite that hasn't been asked to cough up a euro cent: the European Central Bank.
According to estimates by JP Morgan, around €120bn (£100bn) of Greek government bonds are held by large banks and €80bn by hedge funds. But analysts at Royal Bank of Canada judge that an additional €44bn is held by the ECB, accumulated when the central bank was attempting, in vain, to stabilise the Greek bond markets in 2010.
So why not get the ECB to "contribute" to the Greek debt forgiveness project? There would be two advantages for Greece – and by extension the country's backers in the eurozone and the International Monetary Fund. The first is that Athens would get greater debt relief than it is on course to receive if the present negotiations are ultimately successful. This would help to put Greece's public finances on a more sustainable path.
The IMF would certainly find this attractive. Its analysts are reported to have warned that with the Greek economy still contracting at an alarming rate, the present plans to impose a 50 per cent haircut on the private sector bondholders will not be enough to put Greece on the fiscal straight and narrow. ECB involvement could help to make the restructuring more credible from a macroeconomic perspective, bringing down Greece's debt-to-GDP ratio at a faster rate.
Peter Schaffrik, an economist at the Royal Bank of Canada, also argues that ECB involvement in debt relief for Greece would help to calm the wider bond markets by making it clear that all eurozone bond holders will be treated equally. "At the moment the ECB is de facto senior," he says. "It's not a good thing because if the ECB keeps buying Spanish and Italian debt that makes private holders of the bonds automatically junior."
This, he argues, makes them less likely to buy Spanish and Italian bonds. So, perhaps paradoxically, if the ECB were to make a contribution to the Greek writedown, market confidence in the debt issued by other eurozone states would improve.
That sounds somewhat overoptimistic to me. But the principle that all holders of Greek bonds should be asked to take writedowns – no matter who they are – is certainly an attractive one.
Would it be inflationary if the ECB agreed to take losses on its sovereign bond acquisitions? Not necessarily. The actual capital losses on the ECB from a contribution to the Greek restructuring package would be relatively small, maybe in the region of €17bn (since it brought them at a discount to their nominal value). And so long as eurozone governments agree to make the central bank whole for any losses, there will be no inflation at all.
For some, though, this whole direction of travel is wrongheaded. There is a school of thought that says the eurozone crisis really got out of hand after Germany first broached the idea that private sector Greek creditors should take some of the pain of bailing out the country around the time of the G8 Deauville summit in October 2010. It is said that this rash move set off a broader panic as investors suddenly began to wonder whether their other holdings of eurozone bonds were really "zero risk", as they had been led to believe. Athanasios Orphanides, the Cypriot representative on the ECB, even suggested this month that the entire Greek writedown project should be abandoned for this very reason, arguing that Greece's governmental backers should instead commit to meeting the country's financing needs indefinitely.
This view is beginning to look increasingly like denial. Greece is demonstrating that when countries have too much debt, they need debt restructuring. This is perfectly proper. Where there is foolish borrower, there is also a foolish lender. This applies not only to Greece, but also to Ireland, which needs debt forgiveness just as urgently. In 2008 the government in Dublin bailed out its own banking sector, under heavy pressure from the ECB, which was concerned about wider financial stability. In the process, Ireland destroyed its own public finances. Two bust banks, Anglo Irish and Irish Nationwide, were recapitalised with a €31bn loan from the ECB, which the Irish government itself committed to pay back. Dublin is trying to persuade the ECB to lower the interest rate on this loan, something that would reduce Ireland's national debt-to-GDP ratio, which is presently on course to hit 120 per cent by 2013. The ECB should grant this request.
When it becomes clear that a country's debt cannot feasibly be paid back, it must be written down. And no creditor should be untouchable. Not even the European Central Bank.