And so we are back to the same fiscal feudalism that Germany demanded, and the Greece refused weeks ago. We have been pondering the ECB bond swap 'news-story' and the market's reaction to this with incredulity. Our earlier discussion of the deal (here [11]and here [12]) pointed to the problems and now Peter Tchir explains how this debt swap is actually a step towards a Greek default (thanks to the removal of the CAC-encumberance within the ECB). It is also a large step towards colonization as the FT notes that the bailout terms will contain "unprecedented controls" on Athens. It is our earlier comments on the unintended consequence of this ECB action - that of explicitly subordinating all other sovereign bondholders in Europe, and that this would likely raise the very large specter of legal action by other Greek bondholders arguing the ECB has received unfair treatment - that the FT also brings to investors' attention (which is seemingly being ignored on the eve of OPEX). Whichever way you look at this - it is not good for Greece and could have significantly negative implications for the rest of the European sovereign bond market just as investors are starting to dip a toe in the cool risk water once again.
From Peter Tchir:
Firstly this debt exchange story is still that, just a story, and just doesn't read right. It feels like either the reporter didn't understand the source, or the source had some key detail wrong, but let's pretend it's true.
Well, early this week I tried to put some ideas down on what Greece should be doing. The key is ensuring that they have financing in place after a default. An operating central bank would be helpful and the ECB was on the list of groups that Greece needs to deal with. The exchange seems very favorable to the ECB. No notional reduction - which frankly seems greedy - why not just take a notional amount equal to the cost basis. Most importantly, it looks like the ECB is trying to segregate its holdings from the "private sector" bonds. This step would make it easy for Greece to default on old bonds and remain current on new bonds. Maybe that encourages greater participation, maybe it won't. Why would Greece cut a special deal with the ECB that is so favorable to the ECB? Did they negotiate continued ECB support for its bonds as part of the exchange deal? I really don't understand the exuberance over the story (which really does seem to be off).
On the other hand, maybe the problem is solved. Italy issued a 100 billion 30 year bonds with a 1% coupon. Banks buy these at 50 on the auction (since the ECB can't participate in auctions). The banks then sell the bonds to the ECB for 55 . The banks build equity capital quickly since 5 points on a 100 billion adds up quickly. The ECB then exchanges these bonds for new bonds with a 1.1% coupon. It distributes the 45 points of "profit" to the Italian central bank. Italy would owe 1.1% on 100 billion of debt due in 30 years. Italy would have received 115 billion from the sale of the original bonds and their share of the ECB profits based on the exchange. The banks will have made 5 billion on a single trade. Repeat this as often as necessary. Does this sound stupid? If so, how is it so much different than the bond swap story the market is so excited about?
and from the FT: ECB avoids forced losses on Greek bonds [13]
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However, the deal secured by the ECB for its Greek holdings could undermine its intervention in other eurozone government bond markets, by raising fears among private sector bondholders that it would also receive preferential treatment in any future bail-out. It could also trigger legal action by other Greek bondholders arguing the ECB has received unfair treatment.
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and further from the FT: Athens faces tough bail-out terms [14]
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A €130bn bail-out of Greece will contain unprecented controls on Athens’ ability to spend aid, officials said, as European leaders scrambled on Thursday to paper over their division... If the deal is finalised by Monday, it will still include a list of 24 “prior actions” that Greece must complete by the end of the month, before aid is released.
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And so, as we noted above in the introduction (despite Weidmann's insistence just yesterday [15] on non-profit sharing and concerns on monetization - which this seems to be more like just a simple legal action to remove CACs) we are back to the same fiscal feudalism that Germany demanded, and the Greece refused weeks ago.
It seems like nothing has changed for the positive here in terms of Greece's debt sustainability, the PSI is unchanged simply because the blocking-stake holders that we have been so adamantly describing will not budge (and why should they) and now we will likely see non-UK law sovereign bonds for Portugal (and perhaps Spain) also being sold again to avoid the long-arm of Draghi.