Didn't we already know that the public finance was problematic in Greece? We did. But why is it that this piece of information didn't create a chaos until just now? Why did it take us until now to realize the spectre of public debt that has been haunting Europe? Are you aware, that there is actually no increase in the risks? It is just that tolerance to risk is decreasing. Sensitivity of balance sheets against risk all of a sudden increases. But how does this happen? Why do the risks that everyone was perfectly okay with carrying yesterday, become so unbearable, today? Unless this question is answered in a fulfilling manner, I think it is somewhat hard to discuss that the Greek crisis will not be able to be solved without a debt swap like the Brady Plan. Let's first have a look at the question, and then we can move on to the Brady Plan we started talking about last week.

First of all, it is important we realize that this crisis is different from the previous one. The Greek crisis, or the spectre of public debt that has been haunting Europe, is not directly an extension of the 2008 crisis. The Greek crisis, it seems to me, is the first sign of the tightening of liquidity that the 2008 crisis caused. That's why this matter shouldn't be perceived as "Whatever; there were a set of bad risks in the balance sheets of the banks before, caused by securities based on properties which rooted from real estate loans. This time some other bad risks have started to emerge just like that time before." Here at this point, I might also add 'probably', just to be cautious. The 2008 crisis hit the balance sheets of the banks. It created an environment that would permanently limit the amount of liquidity circulating throughout the world. What will be done in the name of public reforms will contribute to this tightening, as well. If funds abundantly circulating across the blue planet are to contract, in that case, some of the assets carried in balance sheets should no longer be. I think what we are faced with today is a process of global liquidity tightening. The effects used to be less visible; the central banks were compensating the decrease in private funds. Now, as the central banks get normalized, the liquidity will tighten, and thus, the efforts of 'decreasing the bad risk' that we've started to see in balance sheets, will continue. So, it is beneficial to look at the Greek crisis as a post-crisis recovery process syndrome. What's more, this is only the beginning of the process. This, is the first point.

This first analysis should be followed by this: the recovery process seems to initiate a bad risk hunting process which will limit the momentum of the recovery process, itself. So it would be better to expect the recovery to be slow. This is the second point. Here is the third: if you fail to manage the recovery process syndrome, it still holds the potential of forming a second rock bottom, though may be not as deep as the one that emerged in the 2008 crisis. I guess this is exactly what the recent events have proved to us.

But why did the EU fail to manage the problem of converting the debt stock that broke out in Greece? Firstly, I think it wasn't quite understood that this was a part of the balance sheet downsizing process which was especially concentrated on throughout the recovery process of the 2008 crisis. It wasn't about Greece. It was about the balance sheets of banks and other financial institutions. Thus Greece was in the center of a process that not only concerned a group of financial institutions, but all the financial institutions around the globe. Let's remember and focus on this hypothesis a little bit more, some other day.

Secondly, two steps were taken in response to the Greek crisis. The first one was a stabilization programme which would allow Greece to step into a quick fiscal contraction process along with the IMF. The second was the EU support of approximately US$145 billion to back the progamme. But that didn't work. Why didn't it work? I said the reason back then, I will say it again: Because, the interest rate of the support was too high. The problem was not the timing, it was the cost. The Greek people were being tortured by the support package, but the public debt stock/national income rate actually reached to %150 from %120. The calculation didn't add up to a sustainable public debt stock. The EU came to the rescue, but the interest of the recovery package was equal to that of a usurer's.

As a third point, let us underline that the interest rate of the back-up of the IMF was 1.25. That, in fact, was a good rate but this time the amount was not enough.

Now, what was missing in that package? The missing part was the reconstruction of Greece's public debt if the interest rate was to be that high. It was a debt-swap. What did that mean? It meant replacing the existing Greek bills with new ones which had longer maturities and lower interest rates. Turkey did this once in the past. Now it was Greece's turn. This way, a part of the cost was going to be paid off by banks and other financial institutions. It was going to be possible, with a 'voluntary' debt swap, to transfer half the cost of the fiscal adjustment to be shouldered by the Greek people, to the financial sector. But this wasn't done. Let this be the fourth analysis of the day.

Here comes the fifth: EU's $1 trillion support through a front company would allow this debt swap to be done securely. It appears the EU will have to develop its first 'Brady Plan', for Greece. The EU has two options ahead: It will either undergo a set of institutional reforms necessary for the coordination of public finance, or find a solution to this problem which has emerged throughout the recovery process, by developing a 'Rehn Plan', instead of 'Brady Plan'.  The first one is a long, costly and a political process. The second can be quite technical and quick. Since there isn't much time, a debt swap system based on a 1 trillion $ collateral portfolio is urgently needed. Without that, this problem can't be solved.

Let's wait and see what will happen. Here's what should be kept in mind: If it wasn't for this downsizing in the financial sector, the Greek bills wouldn't pose such a huge risk. It would be beneficial to start thinking about what other difficulties the post-crisis recovery process can cause in the balance sheets. This, is the first point. The question that should be kept in mind is this: Is taking regulatory measures on limiting the liquidity further, good or bad for the recovery process, in the current milieu? Let's think about that...

This commentary was published in Referans daily on 20.05.2010