The idea that a Greek debt restructuring could be carried out in an orderly way is a fairytale, European Central Bank board member Lorenzo Bini Smaghi said in an interview published on Monday.
If you look at financial markets, every time there is mention of a word like 'restructuring' or 'soft restructuring' they go crazy -- which proves that this could not happen in an orderly way, in this environment at least, Bini Smaghi told the Financial Times.
He also warned against a debt 'reprofiling', or voluntary extension of Greek bond maturities, saying it would be hard to get investors to agree to such a deal without the use of force.
If you are a rational agent, you would probably say No. But you might be induced to accept if the government would tell you that unless you accept the next offer will be a 50 percent haircut -- it would threaten you.
Then it is not voluntary but a forced restructuring, which would trigger a series of credit events, CDS payments, so it is in all respects a restructuring.
In the current environment, the ECB may also have to delay a decision, expected at its June 9 meeting, on whether to extend guarantees to provide banks with unlimited one-week, one-month and three-month liquidity beyond mid-July.
I am not sure if we will have sufficient data to take a decision in June, Bini Smaghi said, suggesting the bank may make a last minute decision in its July 7 meeting.
Greece took a 110 billion euro ($157.5 billion) rescue package from the European Union and International Monetary Fund, but has since fallen short on its deficit reduction commitments, heightening the risk of a default on its 327 billion euro debt -- equivalent to 150 percent of its economic output.
The ECB has been a consistent opponent of restructuring and Bini Smaghi ratcheted up the rhetoric once again, saying a debt restructuring, or exiting the euro, would be like the death penalty -- which we have abolished in the European Union.
He added: If Greece defaulted, the Greek banking system would collapse. It would then need a huge recapitalization -- but where would the money come from?
ECB rules that ban it from lending to insolvent banks would also mean it had to shut Greece's banks out of its lending operations, Bini Smaghi said.
A default would leave the central bank nursing losses on the Greek government bonds bought over the past year as emergency support for Athens, though the pain would be worse for euro zone taxpayers.
The ECB bought 6 billion euros of the 77 billion euros of Greek, Irish and Portuguese bonds bought under its purchase programme. The remaining 71 billion was bought by national euro zone central banks, institutions that governments would have to recapitalize if they were hit with default losses.
The Italian said Greece could reduce its debt by selling assets and changing its tax and expenditure systems. If you look at the balance sheet of Greece, it is not insolvent, he said.
Officials from the European Union and International Monetary Fund are expected to deliver their verdict this week on Greece's efforts to bring its budget deficit under control.
(Reporting by Mark Trevelyan and Marc Jones; Editing by Mike Peacock)