My guess is that the foreign non-banks, from which the strongest support for restructuring has come, would vigorously oppose a haircut from which the IMF, ECB, EU, and banks were held immune. Moreover, I suspect that they would also oppose a deal that imposed an equal haircut on all parties and then also assessed a surcharge on all parties for the costs of banking recapitalization. The reality is that banks would be more adversely impacted than some of the other holders of Greek debt due to having to meet mandatory capital requirements. They would need to raise capital, and with little luxury for waiting, they would very likely wind up with a higher cost of capital. Finally, were Greek debt restructuring to lead to spillovers, I highly doubt that the foreign non-banks would be willing to help cover the costs of the resulting fallout. IMO, it is always easier to advocate a risky debt restructuring when one has much less at stake and is largely insulated from the consequences e.g., having to share in the costs of the externalities associated with such a move. The foreign non-banks' exposure would essentially be limited to the extent of the restructuring. The Greek non-banks would also face exposure to the macroeconomic impact in Greece. In contrast, the EU's, and ECB's exposure is not largely limited. Both would likely have to bear the full burden of the costs associated with banking recapitalizations and a disproportionate share of the costs of any spillovers that would follow.
Having said this, I don't rule out such a move, but only if it were accompanies by substantial structural reforms and some kind of mechanism to mitigate the impact of spillovers. The timing would also have to be careful. If the restructuring occurred in the face of growing expectations of a default, rather than after some kind of stabilization had been achieved and progress was being made, the move could be seen as a self-fulfilling prophecy. If so, markets could react adversely and abruptly in other indebted countries (Ireland and Portugal being likely candidates) and possibly spread into Italy and Spain despite differing circumstances. The latter outcome would be particularly hazardous to the EU and would pose a global risk.
The experience with sovereign debt default has been a loss of such access for a period of time. Sometimes, loss of access has lasted for an extended period of time e.g., Argentina. Moreover, while Greece's relatively high debt has led to the current crisis, that debt is really the symptom of a much larger need for structural reform. The cause of that debt is the structural revenue-expenditures imbalance. Without tough structural reforms, including major tax policy changes, a reduction in Greece's debt would offer a temporary remedy.I also disagree that this would mean that Greece wold be cut off from funding down the road. Just the opposite. Greece would then have a debt burden that would allow people to have a better sense that it can be paid. Interest rates could find a normalized number using Germany as Europe's equivalent to treasuries.
I agree about the political sustainability of the situation. Indeed, that dynamic is in play in the U.S. to some extent, even as the U.S. faces choices far less painful than those confronting the Greeks.This is just my view but the ECB like the Fed wants to kick the can down the road. I see your concerns above and some are valid. But what would you suggest? The Greek public does not want to take all the burden and at the end of the day will not. Bondholders will have to take a haircut.
Given the information I have at present, including the prevailing market psychology, my suggestion would be to provide one more tranche of assistance in exchange for:
1. Structural reform (austerity) to address the structural problems (tax, expenditures, benefits) leading to Greece's increase in debt.
2. Sizable sales of Greek government assets to cut operating costs of the government and to raise cash to reduce outstanding debt (preferably > 100 billion Euros over the next 12-18 months). All proceeds would automatically be used to buy back debt. Priority could be given to debt held by the EU/IMF (lenders of last resort) and then the banking system (to reduce the recapitalization costs from any future restructuring). Clearly, many holders of Greek debt would find such priority "unfair." But the reality is that they are not likely to be willing to share in the externalities associated with a restructuring, hence measures that could minimize the overall costs of restructuring would make sense.
3. An EU/IMF Board that would serve as a sort of "Budget Office" to monitor Greece's progress and lend technical assistance to the government. This Board would have full access to all of Greece's fiscal data. It would produce monthly reports to provide the kind of transparency Greece has lacked to date.
4. International cooperation to expedite efforts to repatriate assets tied to tax evasion. An amnesty period for tax evaders to pay their obligations. Passage of the amnesty period should result in substantial penalties for tax evaders.
5. Once things have stabilized and there is reasonable consensus that the structural problems are being addressed, I would not necessarily oppose some form of restructuring. However, my first preference would be the Eurobond approach, modeled after the Brady bonds.
I do believe a preemptive restructuring early on when there were few expectations of a default might have been feasible, despite various risks. But that moment of opportunity has passed.