Minutes ago we presented Goldman's twisted and conflicted take on Greece in a post PSI world. Needless to say, virtually everything goldman says is to be faded. Which is why not surprisingly, the next analysis, a far more accurate and realistic one, does precisely that. In a just released report from Europe think tank OpenEurope, the conclusion is far less optimistic: "The deal sets the eurozone up for a political row involving Triple-A countries. At the start of this year, 36% of Greece’s debt was held by taxpayer-backed institutions (ECB, IMF, EFSF). By 2015, following the voluntary restructuring and the second bailout, the share could increase to as much as 85%, meaning that Greece’s debt will be overwhelmingly owned by eurozone taxpayers – putting them at risk of large losses under a future default. This deal may have sown the seeds of a major political and economic crisis at the heart of Europe, which in the medium and long term further threatens the stability of the eurozone."
From OpenEurope (pdf version [12])
A small step forward, but the Greek restructuring deal could prove to be a pyrrhic victory
Open Europe has responded to the agreement between the Greek government and its private creditors which laid out how much and under what format the country’s massive €360bn debt burden should be written down. The deal involved private sector bondholders agreeing to a 53.5% nominal write-down, while so-called Collective Action Clauses (CACs) will be used meaning that Greece is now technically in a state of default – precisely what EU leaders have spent two years trying to avoid. While marking a small step forward, Open Europe notes that the deal is unlikely to save Greece, and that the country is still on course for a full default in three years’ time, if not sooner.
Open Europe’s Head of Economic Research Raoul Ruparel said,
“With the use of CACs Greece has entered a coercive restructuring or default – something which Greece and the eurozone have spent two years trying to avoid. While the financial markets can handle the triggering of CDS that this will entail, at some point serious questions need to be asked over the amount of time and money which policymakers have wasted on what has ultimately amounted to a failed policy. Instead, Greece should have undergone a full restructuring combined with a series of pro-growth measures.”
“There will be plenty of optimism in the corridors of power around the eurozone today, some of it justified – Greece has avoided a chaotic and unpredictable meltdown. However, this deal could end up being a pyrrhic victory: the debt relief for Greece is far too small which means that another default could be around the corner, while the austerity targets are wholly unrealistic and kill off growth prospects. Furthermore, Greece’s debt will end up being almost completely owned by eurozone taxpayers and by exempting official taxpayer-backed institutions from the write-down, the deal has created a distorted, two-tier bond market.”
Breaking down the key figures
Greek law bonds (Total €177bn) – voluntary participation 85.8% (€152bn) – with CACs 100% (€177bn)
Foreign law bonds (Total €29bn) – voluntary participation 69% (€20bn) – CACs unknown (to be settled by 11 April)
Total private sector involvement (PSI) participation so far – with CACs 95.6% (€197bn)
Total level of nominal write-down achieved so far – €105.4bn (This is short of the €107bn assumed under the EU/IMF/ECB troika debt sustainability analysis, meaning that more foreign law bondholders will have to participate or not be repaid).
Money needed to push PSI through - €93.7bn
‘PSI LM Facility’ (Bond sweeteners for private creditors) - €30 billion
Bond Interest Facility (EFSF bonds to pay off accrued interest) - €5.7 billion
Bank Recapitalisation Facility - €23 billion
ECB Credit Enhancement Facility - €35 billion
Under this scenario Greece is getting a €105.4bn write down, but taking on at least €58.7bn in new debt straight away. The EFSF, the eurozone bailout fund, is also taking on a further €35bn (by issuing additional bonds) to ensure Greek banks can still borrow from the ECB.[1]
What will this deal mean for Greece and the eurozone?
- The debt write-down offered to Greece is far too small to allow Greece any chance of recovery. Of the total amount (€282.2bn) that is entailed in the various measures now on the table to save Greece – through the bailouts and the ECB – only €159.5bn, or 57% will actually go to Greece itself. The rest will go to banks and other bondholders.
- The use of CACs will almost certainly trigger the pay-out of Credit Default Swaps (CDS) in relation to Greek debt. Despite the opacity and secrecy surrounding the CDS market, there is little evidence to suggest that financial markets will be unable to cope with paying out on Greek CDS. Sellers of CDS have had plenty of time to prepare for this eventuality. Any who are not fully prepared or cannot bear the cost were likely taking irresponsible risks or have much deeper solvency problems.
- Greek banks have taken substantial losses. These banks will be recapitalised, but ‘only’ by €23bn. In contrast, to meet the 9% capital requirements set by the European Banking Authority, Greek banks could need between €36bn and €46bn. It is unclear if further money will be forthcoming, but valid questions will continue to be asked about state of Greek banks.
- For the most part, Greek pension funds (which held around €30bn in Greek debt) have seen their assets reduced significantly. Some public sector pension funds did refuse to take part voluntarily. But they are likely to be forced to do so by the CACs. Importantly, it is unclear where Greek pension funds will recover their money from – the political fallout of having to cut pensions would only add to social unrest.
- The Greek government’s threat to default on the remaining foreign law bonds – held by bondholders who have refused to take part in the voluntary restructuring, hoping to be paid out in full – seems credible. However, since most of Greek debt will now be in the form of new bonds and EU/ECB/IMF loans (which do not have cross default clauses related to the old foreign law bonds), Greece can default on these old bonds without being judged in default generally or on the rest of its debt.[2]
- The upcoming Greek elections at the end of April mean that the future of the second bailout package is still uncertain. The two main parties, New Democracy and Pasok, have been losing ground to both far-left and far-right parties. The hope is that these two leading parties will be able to form a coalition government with a clear majority in parliament. Even if they do not win the majority of votes, they may still have a majority of the seats due to the electoral structure in Greece. Even so, it will be a close run election and without a strong majority in parliament, every future vote on new austerity measures, of which there will be many, will be a hard fought battle – not conducive to political stability.
- Under recent proposals, the total level of budget cuts Greece is expected to undergo stands at a massive 20% of GDP by 2013. Historically, no country has ever gone through such a large level of fiscal consolidation – successful or otherwise – especially without the option of currency devaluation. For example, the extensive fiscal consolidation seen in Ireland during the 1980s and 1990s totalled ‘only’ 10.6%.
- Athens is highly unlikely to meet its debt targets by 2020. This means that combined with the poor growth prospects due to continuous austerity, Greece will almost inevitably need either another bailout in three years’ time, or be forced to default on its outstanding debt.
- In parallel, the deal sets the eurozone up for a political row involving Triple-A countries. At the start of this year, 36% of Greece’s debt was held by taxpayer-backed institutions (ECB, IMF, EFSF). By 2015, following the voluntary restructuring and the second bailout, the share could increase to as much as 85%, meaning that Greece’s debt will be overwhelmingly owned by eurozone taxpayers – putting them at risk of large losses under a future default.
- Therefore, this deal may have sown the seeds of a major political and economic crisis at the heart of Europe, which in the medium and long term further threatens the stability of the eurozone.