What happens if Greece puts forward an exchange offer which is acceptable to the Troika (the EU, ECB, and IMF), but unacceptable to bondholders — and only say half of them accept? In that event, there wouldn’t be nearly enough acceptances to be able to bail in the holdouts — and as a result, Greece would be paying out on its new bonds and would be forced to default on the old bonds which weren’t tendered.
Narrowly speaking, this would be good for Greece’s fiscal situation. After all, if it’s only making coupon payments on half of its private-sector debt, that saves it a substantial interest expense. But there’s no sense in which Greece actually wants this outcome — for two reasons.
Firstly, even if the ECB encouraged Greece to offer bondholders a very low coupon, it also doesn’t want Greece to be in indefinite default. Some kind of technical default which lasts for a couple of weeks, before the new bonds are accepted? That’s fine. But a protracted legal fight with bondholders trying to attach Greek assets around the world, and waving Greek obligations which are going unpaid? The ECB certainly doesn’t want that. It might be accepting just about anything as collateral these days, but even the ECB might well draw the line at lending against securities issued by a government which is clearly not paying a huge chunk of its debt.
The IMF, too, has rules against lending into arrears: it won’t lend new money to countries which are in default on old loans. This is a self-imposed rule which the IMF has broken many times, and might well break again, if it can say with a straight fact that Greece made a “good-faith effort” to keep current. But still, the bigger the number of holdouts, the harder it becomes for the Fund to continue to lend money to Greece.
The most devastating effect, however, would probably be on Greek banks. The obligations of Greek banks, pretty much by definition, are less safe than the obligations of the Greek government. Deposits in Greek banks are obligations of Greek banks. And so anybody with deposits at a Greek bank would likely move those deposits somewhere much safer, like Germany. That capital flight would weaken the balance sheets of the Greek banks and force the ECB to make a hard decision about lending not to Greece itself but rather to Greece’s banks. And even if the ECB did prevent Greece’s banks from going bust (certainly the Greek government doesn’t have the money to do that), those banks would be much weaker, much smaller, and much less willing to provide credit to Greek businesses. The Greek economy would surely be severely damaged as a result.
So it’s important, before March 20, that Greece puts together an exchange offer which a significant supermajority of bondholders will accept. It doesn’t need everybody to accept — there will be holdouts, especially when it comes to bonds issued under foreign law. But so long as those holdouts are obviously in the minority, that’s probably survivable. But Greece does need to be able to bail in all of the holders of its domestic-law bonds. Otherwise both the legal dynamics and Greece’s broader economy could become very nasty indeed.