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News : EU Economy Last Updated: Apr 20, 2011 - 8:56 AM


When Finland repaid its debt; Greek restructuring gets attention; Ireland to follow?
By Michael Hennigan, Founder and Editor of Finfacts
Apr 19, 2011 - 7:09 AM

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Pictured at the meeting of the Eurogroup of Eurozone Finance Ministers in Brussels, Monday, Jan 18, 2010: from left to right: Luc Frieden, Luxembourg Minister for Justice, Minister for the Treasury and the Budget, Josef Pröll, Austrian Vice Chancellor and Federal Minister of Finance who retired from politics this month because of ill health, Jyrki Katainen, Finnish Minister for Finance who is expected to be the new Prime Minister, Christine Lagarde, French Minister for Economic Affairs and Wolfgang Schäuble, German Federal Minister for Finance.

Finland is in the news this week because of the surge in support for the anti-bailout True Finns party. The country once won international recognition for repaying sovereign debt in tough times. Meanwhile, the prospect of Greek restructuring has moved centre stage, which will inevitably raise the question as to when Ireland will follow?

The Tsar of Russia had replaced the Swedish sovereign as the ruler of Finland in 1809 and newly independent Finland borrowed just over $8m from the United States between 1918 and 1920 to ease acute post-war food shortages. Finland agreed to repay the loans over a 62-year period, with an interest rate of 3% for the first ten years, and 3.5 % thereafter.

At Versailles, the European victors had got their pound of flesh from defeated Germany and they were deeply in hock to the United States. The economic burden of a vengeful peace was to have calamitous consequences and Winston Churchill wrote in 1927 that a "a knell rang in the ears of the victors, even in their hour of triumph."

In 1922, the US negotiated loan agreements totalling over $11.5bn with 15 European countries. In 1931, it agreed  to a one-year moratorium on all inter-governmental loans. In 1933, only 6 countries made token payments on their loans. The following year, Finland earned the distinction of being the only country to continue to pay the US its principal and interest payments in full.

At a time of economic dislocation across America, there was public resentment in response to the European loan defaults and Finland was praised as a small northern country willing to pay its debts while its more affluent neighbours left them unpaid.

After World War II, Soviet dictator Stalin demanded war reparations from Finland in respect of a war the Soviet Union had started in November 1939. Finland had to pay $300m - - about 7% of its national income - - to the Soviet Union in the form of goods. Finland paid in full by the early 1950’s; its last remittance, the brigantine Zarja, set sail for the Soviet Union in September 1952.

Fast forward to current times, and as Jean-Claude Trichet, European Central Bank president, continues to resist any discussion of the possibility of Greek default, news reports suggest that the issue is getting attention from political leaders.

Der Spiegel reports that the wheel-chair bound Wolfgang Schäuble, who survived an assassination attempt in 1990 when he was German interior minister, hates being disturbed on Saturday afternoons. That's when Germany's finance minister, a huge soccer fan, likes to watch the games of his favorite team, Bayern Munich, on TV.

The magazine says Eurozone finance ministers discussed the prospect of a Greek restructuring on Saturday, April 2, on a teleconference call. It says Trichet's opposition is driven by the ECB's exposure to the Greek sovereign debt it has purchased since last May, when it began to acquire €77bn worth of bonds issued by struggling Eurozone economies including Ireland.

As the governments of the core countries will resist providing any further bailout funds, the concept of 'voluntary restructuring' is getting attention.

George Provopoulos, the governor of the Bank of  Greece said on Monday that the country will intensify efforts to implement reforms to improve competitiveness. He said the economy will contract by at least 3% in 2011 following a 4.5% shrinkage last year.

The governor said that “there would...be very negative consequences for pension funds, banks and individuals,” who had invested in Greek government bonds

Greece's public debt is expected to rise to 160% of GDP in coming years.

Cartoon in Philadelphia Public Ledger. Photo: Courtesy of Bank of Finland.
The Economist says calculations by the Bank of England on losses that would arise from haircuts to Greek, Irish, Portuguese and Spanish debt suggests that a 50% haircut would wipe out 70% of the equity in Greek banks, almost half of it in Portuguese and Spanish banks and about 10% of the equity in German and French banks.

Jacob Funk Kirkegaard, a Danish economist, who has been a research fellow at the Washington-based Peterson Institute for International Economics since 2002, says in an article in Der Spiegel, that after the Latin American debt crisis in the 1980s, US regulators lied about the health of American banks until they were in a position to take a voluntary haircut on their bad loans. The Brady Plan, named after US Treasury secretary, Nicholas Brady, holds important lessons for Eurozone governments looking for a way out of the current debt crisis.

Proponents of unilateral action, within a currency union, whether in Greece or Ireland, are fools. Isolation at a time of economic distress, is not clever.

Restructuring cannot be seen as a means of avoiding reform.

Nicholas Economides, a professor of economics at the New York University Stern School of Business and Roy C. Smith who is a professor of finance at the same school, also propose the Brady solution in an article in the Financial Times today. They write that 18 heavily indebted, distressed Latin American and other countries offered old bank debt for new “Brady bonds,” that were collateralised by a 30-year zero-coupon US Treasury bond.

The European Debt Crisis: For more on the European debt crisis and a look at Monday's market action, Stephen King, global economist at HSBC, joined CNBC:

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