First off, the details of the swap are as follows: the ECB simply exchanged 50€ billion worth of old Greek sovereign bonds (which were soon to be worth much less if not be outright worthless) for 50€ billion worth of new Greek sovereign bonds which would not be exposed to default risk or any kind of debt restructuring (unlike those bonds held by private Greek bond holders).
I want to mention here that the ECB only owned about 50€ billion worth of Greek sovereign bonds to begin with. So they exchanged roughly ALL of their exposure to Greece to new bonds that will not lose money during a restructuring or default.
The message here is clear: all private investor sovereign bond holdings are now subordinate to those of the Central Banks/ the IMF.
The ECB had been toying with this idea of subordinating private debt holders for over a year now: all negotiations concerning a Greek debt restructuring featured private debt holdings taking a “haircut” while the ECB, IMF, and Eurozone countries kept their holdings at 100 cents on the Dollar.
However, this latest move by the ECB has made this arrangement completely formal. Essentially, the ECB just told the private bond market “what we own and what you own are two different things, and ours are the only holdings that are risk free because we make the rules.”
Thus, the academics, who have been governing the private economy and private capital markets for the last four years, have finally made their control of these entities explicit. It’s simply astounding. And the repercussions will be severe.
However, for now, the mainstream media believes this move to be insignificant:
Feared Bond Swap Met With Shrug (from the Wall Street Journal)
A bond swap completed last week aimed at protecting the European Central Bank from a restructuring of Greek government debt was widely seen as unsettling euro-zone sovereign-bond markets. So far, though, it hasn't.
Last week, the ECB swapped the estimated €45 billion to €50 billion ($59.2 billion to $65.7 billion) face value of bonds—bought in the open market in 2010 and 2011 in a vain effort to quell bond-market turmoil—for bonds of the same face value. The new bonds—unlike the old—won't be subject to any forced restructuring like those held by private bondholders.
The above story only confirms that that mainstream media, like the Central Banks themselves, have no concept of the unintended consequences such policies can create: if you’ll recall most coverage of the Fed’s QE 2 announcement only briefly mentioned that some “critics” thought the move might result in runaway inflation. What actually happened were numerous revolutions, riots, and a massive increase in the cost of living as inflation took food prices to record highs.
With that in mind, it is not surprising that the media has not caught on to the true consequences of the ECB’s move. However, the ripple effect this will have on the private bond market is going to be seismic in nature.
The global sovereign bond market is roughly $40 trillion in size. And the ECB just sent a message to all bond fund managers and private financial institutions that their Euro-zone sovereign bond holdings are not only the only holdings that are “at risk” for debt restructuring, but that ECB can change the rules at any point it likes.
This instantly and immediately makes Euro-zone bonds far less attractive to private investors. It was bad enough that the idea of a 50+% haircut on a sovereign bond was on the table. The only reason private Greek bondholders were willing to stomach this was in order to avoid a default/ catastrophe and the total loss of capital.
However, now all private bond investors know that not only will they be shouldering all of the losses during any upcoming sovereign defaults/ debt restructurings but that the ECB can change the rules any time it likes.
Indeed, the only reason the ECB was able to get away with this without causing private bondholders to flee European sovereign debt en masse was because it didn’t take a profit on the debt swap.
In terms of Europe’s ongoing debt Crisis, this move is extremely damaging to any hopes of clean debt restructuring for Greece or the other PIIGS countries (Portugal, Ireland, Italy, and Spain). Remember, this entire round of the Euro Crisis was caused by concerns over 14€ billion in Greek debt payments that were due March 20th.
So what happens once we get into the hundreds of billions of Euros’ worth of sovereign debt that needs to be rolled over in the coming months. The ECB, IMF, and EU have already spent 176€ billion trying to prop up the PIIGS bond markets. What happens now that private bondholders know that any potential restructuring of sovereign bonds for these countries means them taking a large hit while the ECB doesn’t suffer a cent in losses?
Again, we really need to step back and think about what just happened: the entire Eurozone and financial system were on the verge of collapse because of a mere 14€ billion in debt payments from minor country. This should give us pause when we consider the fragility of the financial system.
Regarding the actual Greek deal itself, it:
- Fails to address Greece’s debt issues (the new forecast is that Greece will cut its Debt to GDP ratio to 120% by 2020)
- Slams Greece with additional 3.3€ billion in austerity measures (spending cuts and tax increases) thereby guaranteeing a weaker Greek economy (Greece is already in its fifth year of economic contraction)
- Is anything but guaranteed (Germany and the Netherlands have raised issues that could stop the deal dead in its tracks)
We’re fast approaching the end of the line here. It’s clear that the EU is out of ideas and is fast approaching the dreaded messy default they’ve been putting off for two years now.
Indeed, Greece is just the trial run for what’s coming towards Italy and Spain in short order. NO ONE can bail out those countries. And they must already be asking themselves if it’s worth even bothering with the whole economically crushing austerity measures/ begging for bailouts option.
Which means… sooner or later, Europe is going to have to “take the hit.” When it does, we’re talking about numerous sovereign defaults, hundreds of banks going under, and more. It will be worse than 2008. Guaranteed.
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