The idea of a European Union Budget Commissar to ensure Greek compliance with its reform commitments was floated at a recent European Council meeting—and just as quickly killed as politically impossible to implement. Now Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France have come up with another suggestion to enforce discipline on Greece. A special escrow account is to be created, into which portions of Greece’s bailout funding would be diverted to ensure that the cash is available to make interest payments to Greece’s bondholders. Make no mistake, however. If this account is implemented, it will be a game changer for the debt restructuring deal for Greece, and for the new International Monetary Fund (IMF) reform program and Greece’s relationship with the euro area as well.
Such an escrow account would give Greek bondholders seniority over the spending demands of Greek residents and taxpayers, when it comes to the use of the bailout money provided Greece by the so-called troika of the IMF, the European Central Bank (ECB), and its partners in the euro area. Elevating creditors in this fashion would be politically controversial, especially in Greece, which would be confronting a deep multiyear recession compounded by a significant reduction in fiscal sovereignty for Athens. Unsurprisingly, the likely next Greek Prime Minister Antonis Samaras has a problem with it! The euro area, on the other hand, is likely to note that it is merely exercising its interest in protecting its taxpayers’ money, which has been sent to assist Greece.
In addition, Chancellor Merkel’s intent, obvious though not articulated, is to sequester funds for interest payments only on the new bonds that private bondholders get in return for taking a 75 percent net present value (NPV) write-down on their existing holdings. That deal leaves nothing for the creditors refusing to participate in the debt restructuring, known as the private sector involvement, or PSI. Thus an escrow account offers a powerful incentive to secure a higher participation among creditors in the PSI bond swap. Bondholders would in essence receive a de facto (albeit smaller) claim in the euro area in return for their Greek debt, as the new escrow-guaranteed bonds would be the functional equivalent of a eurobond. An escrow account for Greece’s new long-term swapped bonds (which will have a maturity of 30 or more years) also means that finding the funds to pay back the principal will literally be the problem of future generations of euro area leaders.
To guarantee this outcome—required if euro area leaders want to be faithful to their promise of ending the experiment of PSI, the euro area must ensure that the escrow account is big enough to guarantee that no further sovereign defaults would happen against the holders of the new bonds.
Beyond these considerations, an escrow account would have very important implications for future brinkmanship between Greece and the troika over Greece’s compliance on reform. Until now, successive Greek governments have argued that the troika has no choice but to pay the next loan tranche, knowing that the associated contagion from a sudden unstructured Greek default would be devastating for the entire euro area. Accordingly, Athens has been able to get away with its deficient program implementation. Note that for Greece, missing a deficit target because of adverse economic conditions is more acceptable than a failure to deliver structural reform because of politics.)
With an escrow account this brinkmanship calculus changes completely. Faced with Greek intransigence on reform, the euro area will be able to use the escrow account to keep international bondholders happy and eliminate the threat of contagion from a second Greek default, while selectively shutting off funds for the running of a Greek government. Athens would thereby lose its principal contagion leverage against the euro area and also lose its ability compel the troika to continue to disburse cash.
An escrow account for bondholders, combined with a likely enhanced euro area/IMF financial firewall against contagion, to become operational by July, would disarm the Greek government in future games of chicken with the euro area. By lifting the threat of potential turmoil throughout the region caused by a Greek domestic default and subsequent meltdown, an escrow would really put the screws on Athens.