This week has seen a new proposed deal for dealing with the debt problems of Greece. As there are genuine changes you could call this bailout version three or indeed four if you take the debt haircut (Private-Sector Initiative or PSI) as another. Indeed we can gain some perspective on this by considering the PSI itself.
The PSI or default
It was only in March that Greece adopted a 53.5% haircut or default on the approximately 206 billion Euros of privately held Greek government bonds. However the supposed gains turned out to be much less than you might think as I pointed out at the time. The sovereign-bank loop came into play as we saw that a 50 billion Euro bailout of Greece’s banks would be required due to their holdings of Greek government bonds. One or two bonds have had to be paid out in full. Also she had to provide “sweetners” to the deal of 35.5 billion Euros which meant that by the time everything was done you start to wonder how much was gained in practice. In the Mad Hatters Tea Party world of Euro area finance there were calculations made which suggested that Greece would be worse off and had suffered what might be called an anti-default.
The missing component was the fact that official holdings of Greek government debt were not subject to the haircut and the main player in this regard the European Central Bank set its face against ever doing so.
In spite of all this the troika claimed that such a move would put Greece on a path to reducing its national debt to 120% of its economic output as measured by Gross Domestic Product in 2020. Leaked forecasts in fact showed that not even they actually believed this!
This week’s version
This differed from the above as it added in these factors which the EuroGroup “would be prepared to consider.”
We start with an implict acknowledgement of the point that I made at the beginning of this saga that the debt is likely to be perpetual.
An extension of the maturities of the bilateral and EFSF loans by 15 years and a deferral of interest payments of Greece on EFSF loans by 10 years.
At this point the deal sounds rather like one of the televison advertisements of Ocean Finance. One friendly monthly repayment and all that. It lacks a statement that deferring debts means that the future burden is larger which is a very familiar theme for Greece and a major reason why things have got worse.
This comes with a sweetner that the interest on the debt may be cut.
A lowering by 100 bps of the interest rate charged to Greece on the loans provided in the context of the Greek Loan Facility…..A lowering by 10 bps of the guarantee fee costs paid by Greece on the EFSF loans
So a possible genuine reduction in Greece’s debt costs although there are two catches which I will explain in a moment.
Also the European Central Bank may finally contribute something from its holdings of Greek government debt.
A commitment by Member States to pass on to Greece’s segregated account, an amount equivalent to the income on the SMP portfolio accruing to their national central bank as from budget year 2013.
By SMP they mean the Securities Markets Programme the vehicle via which the ECB bought Greek government bonds in a failed attempt to boost that market.
Where might this go wrong?
Unfortunately this is rather a long list! Let us start with a condition for all this.
conditional upon a strong implementation by the country of the agreed reform measures in the programme period
So to get this Greece has to do what she has signally failed to do so far. One of the features of the troika system is the way that it appears to learn nothing from its experience.
If we consider the proposed interest-rate reduction we face the problem that quite a few Euro area countries will have to borrow at a higher interest-rate than the proposed rate for Greece. If we note that the loans are now for a longer time period we see that the situation has just got worse for them. For Spain and Italy this is a genuine problem and as they are 32% of the programme we see that it has a problem and this is before either of them join this group.
Member States under a full financial assistance programme are not required to participate in this scheme for the period in which they receive themselves financial assistance.
That way the unstable lifeboat I have discussed before sees the waves finally submerge it.
I note that the statement is careful to call the possible addition of money from the ECB’s holdings of Greek government debt as “income” unlike many commentators who have called it profits. There is an income stream from these bonds because they pay a higher interest rate than the cost of the money to the ECB which is currently officially 0.75%. However there is a very large catch here as the ECB started buying some of these bonds at 100 and bought at 90,80,70 and so on whereas even with the recent rallies they are worth more like 30. So there have been capital losses if you use market prices. Just to give an illustration of this Greece’s new (i.e post PSI) bond for 2023 closed last night at a price of 35 and her 2033 one closed at 27.5 according to the Financial Times.
So the ECB actually has very large capital losses on these bonds which it assumes away by telling itself that all bonds will be repaid at maturity at par or 100.
This has a very serious consequence for Euro area taxpayers
Back on May 10th I explained how the ECB was getting par back for the bonds it had bought. In essence via the European Financial Stability Facility the bonds are being bought off them by you if you are a Euro area taxpayer. The detail from back then is here.
As with previous disbursements to Greece, the EFSF will transfer the €4.2 bn into a segregated account which will be used for debt service payments.
On the 18th of May there is a 3.4 billion Greek bond redemption. Who owns that? Er the ECB mostly and maybe virtually all of it although it has never actually declared its holdings. But the 40 billion Euros or so has to be somewhere and it did buy short-dated bonds. So we have come full circle as the ECB creates money and lends it to the EFSF so the EFSF can buy Greek bonds at par from the ECB!
So the use of a special purpose vehicle means that taxpayers are misled. From this there are two very serious consequences. One the Euro area and its taxpayers become ever more exposed to capital losses which would no doubt be presented as a “surprise”. Secondly as the bill ends up with Greece her debt burden continues to rise and the whole effort has a self-defeating component.
Greece debt buy-back plan
This is where the Mad Hatters Tea Party really gets into full swing. As I pointed out on Monday leaking such a plan has meant that prices have risen when such a plan works best the lower prices are. I think that everyone can understand that a buyer would wish to buy as cheaply as possible. So one more time Greece will get a larger bill than was necessary. Also there may not be that many bonds available to buy as so many have been bought already!
I have kept to this point a fundamental failure of the Euro area bailout plan. This is that they have provided more debt and not capital. As the Americans put it some “skin in the game” was always needed. In my opinion this was done to avoid the implication that losses probably would be made which in the passage of time have become a certainty. They have become a certainty partly because of the increased debt burden placed on Greece in a manner of which the Mad Hatter would be proud.
Also in the financial alchemy which desperately tries to find a version of mathematics which gets Greece down to a national debt to GDP ratio of 120% I see some familiar friends. For example economic growth next year and in subsequent years is always stellar. An equivalent weather forecast in the UK over this summer/autumn would have been to continually predict sunny rainfree days! Putting this another way back in 2010 the troika forecast that the Greek economy would grow by 1.2% in 2012 and instead it looks likely to shrink by around 7%.
Even with all that and a deferral of two years in many of the plans the future for Greece’s debt looks horrible and in the end there will have to be some capital applied presumably now by what is euphemistically called “debt forgiveness”. One of the saddest parts of this episode is that much less would have been required in 2010 and it would have meant that some of the economic pain inflicted on Greece since need not have happened.