Wednesday, 19 January 2011 12:45

Rumor Has It That The Germans Are Starting To Consider Real World Solutions To The Greek Debt Dilemma - Restructuring, Exactly As We Anticipated!

Any who have carefully perused my Pan-European Sovereign Debt Crisis series realizes that I have been stating the chances of a Grecian default are very high indeed -Nearly mathematically guaranteed, in a nutshell. I even went so far as to model various scenarios of the Grecian outcome, and the only way that Greece was to have a viable debt to GDP ration was to strategically restructure. See What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates. On that note, it appears that the Germans have been reading my blog.

The NY Times reports: Greece Debt Buyback Has Its Supporters

FRANKFURT — Analysts welcomed talk Wednesday that Greece might reduce its debt load by buying back its own devalued bonds, even though a German government spokesman denied reports that such a plan was in the works. Denials notwithstanding, economists said a buyback would make a lot of sense and could be an important step toward solving Europe’s sovereign debt crisis.

Greek bonds already trade on open markets at a steep discount to their face value. If Greece bought back the bonds with help from other euro-zone countries, the country would not have to pay back the full amount of the debt when the bonds reach maturity. “Ultimately it’s the return to some kind of stable debt path that will provide the biggest turnaround in confidence,” Mr. Cailloux said.

...The latest speculation about a Greek restructuring was prompted by a report in the Die Zeit newspaper Wednesday, as well as statements by two ministers of the Greek government who said Tuesday that extending debt repayments would be a good idea. The Greek government denied it was in talks with private creditors to restructure its debt, Bloomberg News reported.

Economists have long doubted that Greece will ever be able to pay back all the money it has borrowed, especially when its economy is shrinking and the interest rate the country must pay to roll over old debt is skyrocketing. But talk of a restructuring has been taboo among European leaders, who fear that a default by a euro country could permanently undermine the credibility of the common currency. Properly handled, a buyback could bring Greek debt down to a manageable level while avoiding the stigma of default. Unlike a default or mandatory restructuring, a buyback would be optional. Investors could still choose to hang on to their debt until it matured.

Initial market reaction was negative, however. The yield, or effective interest rate, on Greek 10-year bonds rose seven basis points to 11.36 percent, according to Bloomberg data. A basis point is a hundredth of a percentage point. European leaders are under intense pressure to put an end to a year of market turmoil caused by investor doubts about the solvency of countries including Greece, Ireland and Portugal. Policy makers have been discussing ways to strengthen the European Financial Stability Facility, or E.F.S.F., which is the centerpiece of a €750 billion, or $1 billion, rescue package for distressed euro-zone countries.

... Erik Nielsen, chief European economist at Goldman Sachs, speculated that the E.F.S.F. could buy discounted Greek bonds on the open market, then later re-sell the bonds to Greece. The E.F.S.F. would attach conditions to ensure that Greece continued to reform its economy and cut government spending.

“The possibility for the E.F.S.F. to start buying debt in the secondary market is indeed on the agenda,” Mr. Nielsen said in a note Wednesday.

I'm not a fixed income specialist, or anything like that, but if traders recognize that the Europeans are willing to throw good money after bad and buy these bonds in bulk, wouldn't they up the price that they are willing to part with them for? Significantly above what the fundamentals would support, I imagine.

“There are lots of remaining outstanding issues to be sorted,” he added, “but I would be surprised if it’s not included when the full package is revealed, probably in March.”

Actually, I have a pretty good idea of what the plan would look like, and I will elaborate after this excerpt.

There are potential drawbacks to such a plan. It would shift Greece’s liabilities from private investors to other euro-zone countries, which would then have to ensure that Greece followed through on reforms to make its economy more competitive. Mr. Cailloux of R.B.S. said that such a plan would not be a solution for Ireland or other overly indebted countries because their bonds do not yet trade at a big enough markdown from the face value.

The plan might not work for Greece, either, if prices for its bonds rise or if not enough bond holders were willing to sell.

Trust me, the prices will rise, and there will be bondholders who will hold out for more. They all know the ECB/E.F.S.F. have deep pockets, or at least want to appear as if they do, so why not attempt to bilk them for as much as possible? There probably cannot be a voluntary purchase of debt and have the debt remain at highly depressed levels at the same time. The exchange will have to be more or less forced, ex. a restructuring. Here is a likely (and the most likely) scenario along the lines of what is discussed in the times article above.

The first column represents where Greece stands now, basically neck deep in the "you know what". The right column is basically what the NY Times has discussed, sans the idealistic notion that traders and bondholders of the Greek will stand idly by while deep pocketed buyers lift their distressed debt off of their hands at deeply discounted prices knowing full well that the ECB/EFSF will be willing (or compelled) to buy at much higher prices.

In a nutshell, the bond exchange program (which is basically what was proposed in the NY Times article) will either have to have much steeper haircuts involved in order to bring debt/GDP to a sustainable level or considerably lower coupon payments will have to be in order - most likely in conjunction with haircuts. Even at the point illustrated above that renders debt to GDP at 100% or so, investors will take an average 37% blow to the chin. Since many of these investors are leveraged 10x to 40x in order to juice what they thought would be yields (see How Greece Killed Its Own Banks!) you can guess how well they will accept such a proposition.


Readers who wish to see further opinion on Greek restructuring should see What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates. Professional and institutional subscribers can interact with the actual haircut model, already populated with Greek debt inventory, here:

  • Greek Default Restructuring Scenario Analysis
  • Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts

  • Last modified on Wednesday, 19 January 2011 12:45


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    • Comment Link Jim Thursday, 20 January 2011 11:03 posted by Jim

      I love numbers like you do, Reggie, so I am skeptical of the Times and ECB's work to manage public expectations. One number that popped out of a Spiegel article earlier this week was a German official who claimed that less than 10% of the EFSF has been subscribed so far. The EFSF is just over Euro 750 billion. The TOTAL bond payments of all PIIGS over 2011 and 2012 according to Der Spiegel as I noted last week is about Euro 750 billion. Frau Doktor Chancellor faces re-election in Germany in 2013, when another Euro 250 billion will have to be refinanced, and she has said that haircuts will be part of the restructuring. You are absolutely right to drill down into the national data, but it seems to me that we have not yet reached a larger scenario that takes the larger European framework into sufficient account.

      There WILL be restructuring, as she and other European officials have said. They said it will begin in 2013. If the stronger economies pay into the EFSF and that fund gives money to the Greeks to buy their own debt, needing to repay the EFSF, then the ECB looks a lot like a sovereign bank of Europe more than a simple clearing house. It strikes me that the comments the Times lists do not look like sovereign countries restructuring debts in the manner of, say, Argentina. In fact, the move by Spain reported in today's Journal indicates that it will discipline the cajas and help them buy Spanish debt. The buybacks are going to make it hard for the larger bond market to force its will on the PIIGS through the bond markets, WHILE the swap of local debt for ECB debt managed through the EFSF will pressure these sovereign countries to tow the line set by the ECB. You may want to investigate how Hamilton used the US bank in the 1790's to transition away from the separate currencies and policies of the US states under the Articles of Confederation in the 1780's. This is one of the few analogous political economic moments in modern history.

      When you speak vaguely of MANAGEABLE debt/GDP rations, I suspect that you give the 100% line too much credence in relation to the EMU. If the EFSF can stage manage the next two years, which it manifestly has the cash to do; then it can use a whole range of policies along the way to tailor the solution by country. In effect, the ECB is looking a lot like Enron, with its multitude of shell corporations. Because so much of the EU's trade is within the Continent (whether EU, EMU, or otherwise), it has options that China and the US do not have. The ECB can lower interest rates and, now, sell bonds. Richer countries can offer gasoline tax holidays year by year to counteract commodity-push inflation. The EMU could offer incentives to draw Poland, Bohemia or Denmark into the EMU. In fact, today the EU approved a so-called "medical Schengen" zone where insurance payments will be honored across borders for procedures. Unlike Enron, the EMU simply has to pay bonds to folks like Russia, Switzerland, Iceland, the UK, and each other to keep this mess going a long time.

      When you say that "Greece's finances just won't work," I am skeptical because I watched the Soviet Union unravel in 1991 with my own eyes. The Euro will cease working, when people stop growing or shipping food, stop making or shipping goods. It seems to me that the ECB is getting liquidity to the national governments in a timely fashion, which are cutting government services and choosing winners in their financial sectors. Your assumption that bank failures will lead industries to grind to a halt remains unwarranted, in my opinion. Greece is miserable, but it has not melted down in a manner that would force it out of the EMU. That may come, but I find it hard to believe that such a day lies ahead in the next decade for France, Germany, Italy and the Benelux block. The pain and social dislocation will be great, but medical tourism and cross-border work will follow the recent efforts to synchronize all university degrees across Europe. For investors, a big question is how this "creative destruction" will favor certain industries and companies, if the EMU does not unravel. Even if it did, would the Schengen Zone still not create large pressures toward consolidation of business across borders?

    • Comment Link John Ryskamp Wednesday, 19 January 2011 14:15 posted by John Ryskamp

      Does this sound like haircut talk to you?? It sure doesn't to me!!

      ECB's Jurgen Stark: "The Casino Is Still Open"
      Submitted by Tyler Durden on 01/19/2011 13:43 -0500

      Ben BernankeEuropean Central BankGlobal EconomyGreeceIrelandUnited Kingdom

      •*DJ ECB's Stark: "The Casino Is Still Open" - this comes from one of Europe's top central bankers!
      •*DJ ECB's Stark: "No Sign Of Necessary Change In Banker Mentality" - that's becasue we are aiding and abetting
      •*DJ ECB's Stark: "Inflation in emerging markets is a serious problem" - Bernanke has it 100% under control
      •*DJ ECB's Stark: "increase in Euro region inflation due to energy prices"
      •*DJ ECB's Stark: "ECB's inflation assessment has not changed in mid term" - But naturally
      •*DJ ECB's Stark: "Is very vigilant on possible inflation risks" - so was Tunisian president Ben Ali
      •*DJ ECB's Stark: "Global economy and Euro region recovered faster than thought"
      •*DJ ECB's Stark: "US, UK Deficits Worse Than Euro Zone's" - Don't tell Tiny Timmah
      •*DJ ECB's Stark: "Greece, Ireland Need U-Turn In Economic Policy"
      h/t London Dude Trader

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