The situation in Greece deteriorated further this week as negotiations over the next round of austerity measures led to the resignation of Greek Finance Minister George Papaconstantinou and a reshuffling of Prime Minister George Papandreou’s cabinet. The spike above 2000 basis points in the graph below came on this news Thursday, in addition to speculation that the Greek bailout train may be halted once and for all.

The market has long accepted that the end for Greece will at least be some sort of restructuring of outstanding debt. A restructuring would extend the maturities of outstanding debt – a 1-year bond becomes a 5-year bond, a 10-year becomes a 20-year, a 30-year becomes a perpetual zero (ok maybe not a zero) – but in theory the holders would receive their principal eventually. Interest costs for the Greek Government are currently more than 100% of tax receipts, a problem hardly solved by postponing the maturity of debt. This is leading more of the market to lean toward thinking principal haircuts are the only way to take a bite of the problem.

The ECB has been adamantly opposed to haircuts, or actual realized losses, due to fears of European contagion effects from the big banks down through the financial system. But on Thursday afternoon it appeared that this weekend might be the weekend Greece is forced to take real action. On Friday however, Germany showed interest in exploring a voluntary rollover of debt, where bondholders would essentially promise to buy more debt after their bonds mature.

Friday’s news has caused the market to step back from the “this weekend is finally it” mindset, but even with considerable investor cooperation most people believe voluntary rollovers would buy Greece another month at most. The credit rating agencies have already disclosed that a restructuring would constitute a credit event, but the jury is still out on whether a voluntary rollover does. It appears this weekend will fail to materialize into D-Day for Greece, but even if something does end up happening, it is likely to continue to drag on for some time. ECB support of any kind will have to be accompanied by further austerity, which is getting harder and harder for the Greek government to institute.

Have a great weekend.

Cliff J. Reynolds Jr., Investment Analyst