In June 1992, Greece issued five-year bonds with a face value of $250m at a rate of 8.25 per cent. The spread between the five year Greek bond and the equivalent German Bund was roughly 228 basis points. Greece had a deficit of 11.5 per cent of GDP and a debt to GDP ratio of 110 per cent. Its S&P credit rating was a miserable BBB-.

In June 2008, Greece issued five-year bonds with a face value of $1.5bn, at an interest rate of 4.625 per cent. This time the spread with the equivalent German Bund was only 113bps, half of what it had been in 1992. Greece’s S&P rating was now a respectable A. Yet the underlying numbers had not improved that much. The deficit was 5 per cent of GDP and the ratio of debt to GDP was 98 per cent. And Greece was known to have fudged its financial health in official data.

There’s more. In the early 1990s, Greek debt contracts had numerous provisions that protected creditors from default. The debt contracts gave bondholders the right to accelerate upon an event of default. They committed Greece to membership in the International Monetary Fund and access to IMF funding — which meant monitoring by the IMF. And it appears (although it is hard to verify) that a major portion of Greece’s external debt was governed by some combination of English and US law. In the early 1990s, the credit market treated Greece as a third world country — like Ecuador or Venezuela.

By 2006, the contractual protections for external creditors had been narrowed. In its English law bonds, the right of acceleration could now be exercised only with the consent of bondholders holding 25 per cent of the outstanding debt. Greece also no longer had to retain membership in the IMF with access to its lines of credit. Most important, a large fraction of the bonds held by external creditors was now governed by Greek law. This meant that Greece could unilaterally restructure the debt simply by changing its law. Investors had promoted Greece from third-world debtor to first-world debtor while its finances remained third-world.

What could account for this change? Greece joined the eurozone in 2001. But why should the market have cared that Greece entered the eurozone when its finances did not improve?

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