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Tuesday, February 21, 2012

Many questions around the second Greek bailout remain unanswered

We finally have an agreement on the second Greek bailout…in principle. It only took eight months. If you’re of the belief that a disorderly Greek default would have triggered Armageddon, the deal that was agreed (as ever ‘agreed’ is used loosely) by Euro finance ministers in the early hours of this morning is broadly good news.

Unfortunately, it is once again hopelessly optimistic and contains numerous gaps and unanswered questions which could still bring down the whole deal. This is nowhere outlined better than the damning leaked debt sustainability analysis (see here for full doc).

Below we outline a few key issues (not exhaustive by any means, there are many more) and give our take on how they could play out.

Greater losses for private sector bondholders: Reports suggest the Greek government was sent back to the negotiating table with bondholders at least four times during last night’s meeting. Nominal write downs for bond holders now top 53.5% (or around 74% net present value). The leaked Greek debt sustainability analysis (DSA) assumes a participation rate of 95%.

Open Europe take: 95%, really? We weren’t convinced the previous threshold of 90% with a lower write down would be reached and that was while potential ECB participation was still on the table. Although this target may have been agreed with the lead negotiators for the private sector, it is far from a cohesive group, diminishing the value of the agreement. It will be interesting to see how bondholders respond to the plan but we think that hold outs could well be more than 5%.

Greek ‘prior actions’: The deal includes a list of requirements which Greece must meet in the next week to get final approval for the bailout. These include: passing a supplementary budget with €3.3bn in cuts this year, cuts to minimum wage, increase labour market flexibility and reforms opening up numerous professions to greater competition.

Open Europe take: The now infamous €325m in cuts still needs to be specified. The huge adjustments to labour markets and protected professions mark a cultural shift in Greece – pushing these through will not be painless and could result in further riots.

Fundamental tensions in objectives of the programme: The DSA notes that the prospect achieving a return to competitiveness while also reducing debt is very small – the massive austerity could induce a further recession.

Open Europe take: As we have noted all along the assumption that Greece can impose massive levels of austerity and then return to growth in the next two years is a big leap and almost inherently contradictory. We’d also note that the cuts in expenditure in Greece are larger than have been attempted anywhere in recent memory (successful or failed). Likely to be substantial slippages in the austerity programme while the growth programme remains almost non-existent, essentially closing the book on Greek debt sustainability.

Further favourable treatment for the ECB: ECB and national central banks avoid taking losses on their holdings of Greek bonds but promise to redistribute ‘profits’ from these holdings so that they can be used in Greece.

Open Europe take: See our previous post for a full discussion of this issue. Markets still don’t seem too worried by suddenly being subordinated by central banks in Europe – they should be. This raises questions of the basic premise that all bonds are treated the same, based on who issued them not who holds them. As we’ve noted before, the whole concept of ‘profits’ is misleading, while any distribution would happen anyway – this is not a commitment from central banks but a further fiscal commitment by the eurozone (should really be included in total bailout funding).

Greece may not be able to return to the market even after three years: The DSA points out that any new debt issue will essentially be junior to existing debt, hampering the chances of Greece issuing new debt in 2014/2015.

Open Europe take: This point isn’t too clear but given that the eurozone, IMF and ECB will own such a larger percentage of Greek debt in 2014 any new private sector debt will be massively subordinated and at risk of taking losses if anything goes wrong with the Greek programme. Additionally after the restructuring the remaining private sector debt will be governed under English law and will have the EFSF sweetener – further subordinating any new debt issued to the market. Why would anyone want to purchase Greek debt in this situation (especially given the other concerns above)?

EFSF funding requirements: The EFSF will have to raise €70.5bn ahead of the bond swap – €30bn in sweeteners for the private sector, €5.5bn to pay off interest and €35bn to provide Greek banks with assets to use to gain liquidity from the ECB.

Open Europe take: We’ve already questioned whether raising these funds so quickly can be done and whether the approval from national parliaments will be forthcoming. Even if it is the €35bn is said to fall outside of the €130bn meaning it is expected to be returned swiftly – given the uncertainty over how long banks will need these assets (as long as Greece as declared as in selective default by the rating agencies) this may be a generous assumption.

There is also no talk of the money to recapitalise banks. This is a risky strategy given that Greek banks’ main source of capital (government bonds) will have just been wiped out significantly. The needs were previously specified at €23bn, although reports now suggest they could top €50bn. It’s not clear where this money will come from or when it will be raised. The bond restructuring will be like dancing through a minefield for Greek banks.

We’re still trawling through the responses, analysis and documents to come out of the meeting – meaning there are likely to be plenty more questions and uncertainties to come.

The one thing that is clear is that even if this bailout is ‘successful’, it will set Greece up for a decade of painful austerity and low growth leading to social unrest, while the eurozone will have to provide on-going transfers to help it keep its head above water.

Sorry to be killjoys but as Dutch Finance Minister Jan Kees de Jager put it, the deal isn’t “something to cheer about”.


Rollo said...

The quetion is not only: why should anyone buy Greek debt? but Why should anyone buy any peripheral Eurozone debt, as it could all be subordinated in the same way?

Rik said...

Fully agree: highly indebted; not selfprinting; zero growth (or worse); austerity allergic; structural reformphobic; considerable potential for devaluation; interest-rates manipulated downwards; haircut risk and now juniority risk.
Really a lousy investment. All EZ paper except AAA looks pure or potential rubbish to me.

EZ has only been marginally growing the last decade for the crisis say 2% real growth. Using a normal multiplier and seen the extra credit (sovereign and/or private) it has been financed with. For the coming period very low growth or even zero growth would likely be the norm.
If you would need to transfer furthermore because of all sorts of bail outs or other transfers (whatever the name) money from the most efficient EZ economies to the most inefficient (basically to defer a reorganisation of hardly value adding Southern government sectors (at least on the margin)the next decade and even possibly the one after that might be a lost one. Not only for the PIIGS but also for the rest of the EZ, including the parts that do now relatively well.

And subsequently running straight into the aging crisis. But that is another story.