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The Ugly Truth About The Greek Situation That's Difficult Broadcast Through Mainstream Media
On Thursday, February 17 I appeared on CNBC's halftime show for and hour, and the topic of Greece was the first to pop up. Here is how it went...
My readers and subscribers know that I have been warning that Greece would guaranteedly default as far back as two years ago. As a matter of fact, I stated that the haircut needed would have to be around the 53% mark in order for Greece's economy to truly cash flow again, and that was two years ago when things were much, much better for the country. Now the issue has metastasized into something much worse. How much worse? Well, it's safe to say the situation is at least twice as bad. That being said, twice times 53% means 60, 70, even 75% NPV haircuts just won't cut the mustard. Since this is already a forgone conclusion, I will now release the research and economic models that have been available to BoomBustBlog professional subscribers two years ago (March 2010), take notice how prescient, how crystal balllish it all seems..
Please take the time to go through the model below and click through all of the tabs at the bottom. Professional subscribers who would like a manipulable version of this model in Excel should email me for a copy.
Unfortunately, the embedded spreadsheet that contains the Greek default model is not very easy to embed on ZH, so those interested in seeing the free version should click here, scroll down and view the model as an embedded spreadsheet.
In "With the Euro Disintegrating, You Can Calculate Your Haircuts Here", I explicitly illustrated the likely loss to principal of sovereign debt investors who would be forced to take haircuts "for the cause". While we fully stand behind the calculations and the logic, chances are several sovereigns may attempt to undergo sleight of hand in order to placate investors as best they can. We suspect we will soon be hearing of significant restructuring plans in the Eurozone, starting with Greece. The piece below expands on these thoughts and offers subscribers live spreadsheets that illustrate the potential repercussions. It is recommended that these scenarios be taken into consideration in light of the info offered in the post "Introducing The BoomBustBlog Sovereign Contagion Model: Thus far, it has been right on the money for 5 months straight!" and compared to the haircut analysis as well. All paying subscribers are welcome to review our analytical overview of Greece's public finances (Greece Public Finances Projections) as well as the full Pan European Sovereign Debt Crisis analysis which is freely available to everyone.
Originally published in March of 2010...
Greek Restructuring Scenarios
There are several precedents of sovereign debt restructuring through maturity extension without taking an explicit haircut on the principal amount, and many analysts are predicting something of a similar order for Greece. This form of restructuring is usually followed as a preemptive step in order to avoid a country from technically defaulting on its debt obligation due to lack of funds available from the market. It primarily aims to ease the liquidity pressures by deferring the immediate funding requirements to later periods and by spreading the debt obligations over a longer period of time. It also helps in moderating the increase in interest expenditure due to refinancing if the rates are expected to remain high in the near-to medium term but decline over the long term.
However, the two major negative limitations of this form of restructuring if applied to Greek sovereign debt restructuring are –
- It solves only the liquidity side of the problem which means that the refinancing of the huge debt (expected to reach 133% of GDP by the end of 2010) will be spread over a longer time period while the debt itself will continue to remain at such high levels. The sustainability of such high debt level, which is growing continuously owing to the snowball effect and the primary deficit, is and will continue to be highly questionable. Greek public finances are burdened by a very large interest expense which is approaching 7% of GDP. The government’s revenues are sagging and the drastic austerity measures need to first bridge the huge primary deficit (which was 8.6% of GDP in 2009), before generating funds to cover the interest expenditure and reduce debt.
Thus, even though the amount of funds required each year to refinance the maturing debt will be reduced by extending maturities, the solvency and sustainability issues surrounding Greece’s public finances, which were the primary reasons for it’s being ostracized from the market in the first place, will remain unanswered.
- It will lead to a very material decline in present value of cash flows for the creditors since the average coupon rate is lower than the cost of capital (reflected by the yields on the Greek bonds). The average coupon rate for bonds maturing between 2010 and 2020 is about 4.4% while the average benchmark yield for bonds with maturities from 1-10 years is nearly 7.5%. Also, as the maturity of the debt is extended, the risk increases and so does the cost of capital.
In order to assess the effectiveness of this form of restructuring for Greek sovereign debt, we have built three scenarios in which the maturities of the Greek debt is extended. These scenarios weren't designed to be exact predictions of the future but to represent what may happen under a variety of highly likely scenarios (a pessimistic, base and optimistic case, so to say):
- Restructuring 1 – Under this scenario, we assumed that the creditors with debt maturing between 2010 and 2020 will exchange their existing debt securities with new debt securities having same coupon rate but double the maturity.
- Restructuring 2 – Under this scenario, we assumed that the creditors with debt maturing between 2010 and 2020 will exchange their existing debt securities with new debt securities having half the coupon rate but double the maturity.
- Restructuring 3 – Under this scenario, the debt maturing between 2010 and 2020 will be rolled up into one bundle and exchanged against a single, self-amortizing 20-year bond with coupon equal to average coupon rate of the converted bonds.
In all the three scenarios, we computed the total funding requirements and compared the same with funding requirements prior to restructuring. It is observed that restructuring will help in easing the immediate pressure of procuring funds to meet the huge funding requirements lined up in the next 5 years. However, it will also lead to substantial loss to creditors in the form of erosion of present value of cash flows. (Discount rate was the benchmark yields of Greek government bonds for similar maturity period).
- Under restructuring scenario 1, the decline in present value of cash flows is 9.3% and the cumulative funding requirements between 2010 and 2025 reduces to 155.2% of GDP from cumulative funding requirements of 177.7% of GDP if there is no restructuring. The cumulative new debt raised will decline to 78.6% of GDP from 80.7% of GDP if there is no restructuring
- Under restructuring 2, where the doubling of maturity is also accompanied by halving the coupon rate, the decline in present value of cash flows is 26.3% and the cumulative funding requirements between 2010 and 2025 reduces to 116.9% of GDP. The cumulative new debt raised will decline to 40.3% of GDP
- Under restructuring 3, the decline in present value of cash flows is 18.0% and the cumulative funding requirements between 2010 and 2025 reduce to 131.5% of GDP. The cumulative new debt raised will decline to 69.0% of GDP.
We have also built in the impact of EU/IMF assistance to demonstrate the impact on funding requirements over the period 2010-2025. We assume that IMF/EU will disburse the entire assistance of EUR 110 billion by 2013. The IMF loans will have to be repaid after 3 years from the disbursement date and the payment will be distributed over the next two years. The EU loans will have to be repaid after 3 years from the disbursement date and the payment will be distributed over the next five years. It is observed that IMF – EU assistance will be just a short term relief and Greece will face the pressure when it will be forced to turn to the market to not only fund its maturing debt but also repay EU-IMF loans.
Conclusion – It is seen that the restructuring by maturity extension will marginally moderate liquidity concerns. But the primary and the more fundamental concerns about the high level of debt and the related refinancing and interest rate risks, the huge interest burden, the poor primary balance will be left unresolved by this form of restructuring. The revenues are weak and expenditures are high resulting in huge primary deficit and the government need to first fill this huge gap before it earns a primary surplus to cover the interest expense and reduce debt levels.
The government debt currently stands at 124.5% of GDP and is expected to balloon to 156.1% of GDP owing to lack of funds from primary balance to cover the interest expenditure which continues to add to the government debt levels. The three scenarios built for maturity extension show that maturity extension will not substantially help this issue to contain the ballooning government debt. Under restructuring 1, 2 and 3, the government debt is expected to stand at 154.4%, 123.7% and 147.0% of GDP at the end of 2025.
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greece should pay zero interest on its coupons...7% is criminal. THe ECB should joint and several that ASAP in eurobond at <1%.
Good stuff Reggie though i'm not sure why you gave your CNBC gig top spot for this article!
You're a square peg in a round hole on Fast Money... you need to talk fast shallow immediate-time-zone sugary crap to 'get with the program', not your deep-mined solid long termism
Turn them down next time Dude
Reggie, what kind of Force Majueure clauses do these instruments have with respect to War? What I am getting at is if war is declared (EU/Iran) are "default clauses" and (maybe payments) suspended?
I hear Greece has a fire sale on some realestate.....They can locate the new payday loan company in the former Starbucks.
For the Euro readers of ZH, be sure think twice next time you're visiting Greece about ordering the Tzatziki, and if you're German consider a different destination.
AS one of the few posters here that actually has relatives in Greece, I can say that deferring any resolution is the absolute worst idea on the table. Greeks have become too entitled and lack the necessary resolve to fix their situations. It must be forced upon them. Key factors that would improve it have little direct implications with debt: immigration (illegal and adverse economic impact), tax reform (corruption and non-filers), tourism (needs massive improvement). Given the relative small population there, this country can be fixed. What everyone should be more concerned about is other countries with similar problems in different stages. These countries pose a much larger threat than most people seem willing to admit.
Sorry mate. The Greeks in the private-sector are as hard-working as anyone else. True, they have a massive public-sector which is entirely parasitical. The solution is pretty obvious. Tell the ECB and creditors to get lost and reduce the public-sector to 10% of the economy. Send back those tanks and submarines to Germany and the F-16's to the USA - Turkey is not about to invade them.
the 'solution' for Greece, birthplace of democratic Govt, is not to go from bloated Govt to mini-me Govt.. the correct solution is no Govt
it's not just the 'Keynsian Experiment' that's failed (miserably) ...that's 3rd rate problem solving.
It's Govt that's failed as it has done in every country it's ruined for Mellenium
This is no time for half-arsed solutions like the Tea Party advocate. It's time to face the real problem head-on, deal with it and shut this human shithole of an institution down once and for all
they have nO govt now and they have had this situation for forty years. No govt, no taxes; no nothing except Oligarchy rip-off. That's what you like and that's what they've got. Perfect anarchy and pure Oligarchy. You should be happy. One country in the world follows your rules. To the dot!
Anarchy != Chaos
Long on hyperbole, short on detail. I will provide one. How long have you paid property taxes? Ask the Greeks that question. The answer is only recently. And you wonder this situation has occurred? Just one example. Greeks hard working? LOL!
The Greek government made promises they can't keep.
And a nation signed contracts based on those promises.
The default runs deep...
Concur, but I might add the following:
The Bankers lent money (and earned very nice fees and bonuses on those transactions) to a debtor nation with the FULL KNOWLEDGE that the debt could never be paid back!
"It is hard to convince a man whose income depends on not understanding."
MORAL HAZARD runs deep on both sides......
A report from 2010 is only year old year old news.
The "contagion" that the EU is so fucking worried about will be caused by the ECB and not Greece.
After they exempted the bonds they hold from a "writedown" who the fuck will be stupid enough to own a soverign bond no matter what the return?
The last time I heard of "everyone is equal, just some are more equal then others" it didn't end well.
The ECB is only concerned about itself and not Greece.
I am convinced Greece will default, but the question is still one of when. I could see them taking one more round of cash before telling their creditors to pound sand
Their debt could be 0% of GDP tomorrow if they wanted.
They just have to be willing to live hand-to-mouth for a few years to recover.
But they are going to live hand-to-mouth no matter what they do.
It's just a matter if whether it's their own hand or the banker's hand feeding the mouth and who ends up owning the country after the meal.
Reggie
Yet again using research common sense and reason...Kill Him!!!
for all those armstrong and miller fans out there, TPTB show you just how its done...
http://www.youtube.com/watch?v=mUP3A9imOYU
If the banksters don't call it default, does that mean it's 'just' a haircut?
The amazing thing to me is how many people still have confidence in fiat and any form of government paper IOUs and promises. Fucking blind looser assholes.
Now there's a fitting typo!
ohh I didn't need that visual....
Reggie
Yet again using research common sense and reason...Kill Him!!!
for all those armstrong and miller fans out there, TPTB show you just how its done...
http://www.youtube.com/watch?v=mUP3A9imOYU
They'll brand him sooner or later ad a terrorist for not spouting the party line that all is fine.
How is pumping Google not the party line?
as the tune winds down, so must the piper be paid
If a 75% haircut is really on the table, I think at that point they should just say fuck you, we're not paying anything on those bonds. Just start over. Greece won't make the same mistakes again because they won't have any credit. Pay as you go. No choice but to balance the budget.