The much ridiculed "MLEC-type" bailout proposal of Greece, which contemplates the rolling of existing debt into a guaranteed SPV, and which was the European rescue deux ex machina for exactly two weeks, appears to have been pulled off the table, following the announcement by German Deputy Finance Minister Joerg Asmussen to Reuters Insider TV that "Germany has put a Greek bond swap back on the table as a model for private sector involvement in fresh aid for Athens." More: "The model put forward by some French banks is still a good base for discussions and we are currently working on this. But since rating agencies have signalled that they will consider modalities (such as) the French proposal as a selective default -- that means a rating event -- we can also put other options like a bond exchange on the table." he said, adding discussions would take place over the summer break. Translation: back to square minus one. And actually it is much worse, because if Asmussen is aware of rating agency policy, a debt exchange would most certainly qualify for an event of default. Which confirms our initial expectation from a month ago that there is nothing absent a complete loss of ECB credibility that can possibly transpire next, as the ECB realizes there is no way around accepting defaulted Greek bonds as collateral. The only question is what happens then: will the market, head currently deep in the sand, scramble upon the confirmation that the ECB emperor is naked, or will it continue acting as if nothing has changed yet again.
And while Asmussen is not aware of the nuances of a debt exchange, his colleague Schaeuble sure is:
Finance Minister Wolfgang Schaeuble wrote to his euro zone colleagues, the European Central Bank and International Monetary Fund last month demanding that banks holding Greek bonds swap their bonds for new ones with maturities seven years longer.
But rating agencies signalled then that such a step would be akin to a rating event and the ECB, European Commission and France pushed for a softer solution involving a voluntary debt rollover, prompting Germany not to insist on its bond swap idea.
Ergo: dead end.
More on the currently proposed rescue model:
Asmussen said the French model may set "too clear" incentives for private creditors to participate.
"The model certainly has advantages in the sense that it gives clear incentives for financial market participants to contribute voluntarily. But the question is: are the incentives maybe too generous?" he said.
Work was being done to modify the proposal, especially with a view to lowering the interest rate Greece would pay on its debt, but other options including the bond swap would also be considered.
"First, one has to look how can one modify the French proposal in a way that it is still attractive to financial institutions," Asmussen said.
"But one element one needs to look at is the interest rate that Greece has to pay because the higher the interest rate, the more negative it is for the debt sustainability situation of the country," he added.
This is all fine and great, however, as the WSJ reported yesterday there is one big problem: the private holders have already sold the bulk of their holdings.
Europe's hopes for a significant contribution by private bondholders to a new bailout for Greece are fading, as it becomes clear that banks have sold off a substantial proportion of their Greek government-bond holdings despite pledges by some of the institutions not to do so.
The problem is that the banks and insurers at the negotiating table no longer hold as much of the debt maturing through 2014 as they did a year ago. In May of last year, German banks and insurers made a nonbinding pledge to maintain about €8 billion in Greek debt and loans for three years. Yet the current Greek debt holdings of those institutions suggests they have sold some of their holdings anyway.
There isn't detailed information on how much Greek debt German and other European financial institutions may have jettisoned. Allianz SE, the German insurer, has said it holds €1.3 billion in Greek bonds, compared with €3.3 billion last year. The company has said it would be willing to roll over about €300 million under the current proposal.
So who controls the fate of Europe now? Why hedge funds of course.
Analysts said banks were likely to have sold off short-term Greek debt because it trades at a smaller discount to face value than does longer-term debt. Meanwhile, hedge funds and other investors, who are likely to have bought up the paper, are less likely to be persuaded to engage in the debt rollovers being proposed by euro-zone governments.
Funny: it was precisely a month ago that we explained why "every single Greek bond in recent weeks has been purchased by hedge funds who have remembered that the economics of "nuisance value" when the upside of bluffing the EUR printer is virtually unlimited."
Ah irony: prepare for a massive scapegoating campaign aimed at hedge funds any second, only a diametrically flip flopped one: this time instead of accusing hedge funds of shorting Greece and Europe by being short various sovereigns by being long CDS, hedge funds are about to get bashed in the media everywhere for being... long paper.