Thursday, 01 April 2010 00:00

The EU Has Rescued Greece From the Bond Vigilantes,,, April Fools!!!

On March 26, EU endorsed the proposal of extending aid to Greece (in case it faces shortage of funds to meet the refinancing and new debt requirements) wherein each euro nation would provide loans to Greece at bend over market rates based on its stake in the European Central Bank. EU would provide more than half the loans and the IMF would provide the rest. The official estimates for the size of the planned assistance have not been disclosed since it would depend on Greece's actual need. Erik Nielsen, Chief European Economist at GS, estimates Greece will need an 18-month package of as much as €25 billion, with the IMF providing about €10 billion of that. The French newspaper Le Figaro reports that German officials are estimating the total assistance of nearly €22 billion.

Taking advantage of the positive market response to the
announcement of EU-IMF taking up the role of the lender of last resort,
the government issued 7-year bond with no premium over the market
rates
. However, the euphoria was short-lived. The 7-year
bonds which were issued at yield of 6.0% were trading at 6.27%, the
next day
. The sentiment was also weakened by the poor response to
the surprise auction of 12-year bonds which attracted demand or order
book of just €390 million against the offered amount of €1 billion
.
Judging by the fashion in which the market has accepted Greek debt as of
late, even after announcement of EU/IMG support, it is quite feasible
that the EU's offering of market rate loans is akin to shoveling money
down a black hole in terms of market valuation.

Greece's order book has been shrinking and reflects the waning
market demand for Greek bonds. The 7 year bond auction received orders
of just €6 billion, 20% higher than the offered amount of €5 billion.
This compared with orders of nearly €15 billion for the auction of €6
billion of 10 year bonds on March 4 and orders of nearly €25 billion for
auction of €5 billion of five year bond on January 25.

According to the government estimates, it needs to raise nearly €53
billion in 2010
to meet its refinancing needs as well as fund its
negative primary balance and interest expenditure. Out of this, the
government has so far issued bonds of only €18.5 billion
through:

  • €8 billion of five-year notes on Jan. 26 at yield of 5.93% (381
    basis points more than benchmark German debt of similar maturity)
  • €5 billion of 10-year bonds on March 4 at yield of 6.44% (325
    basis points more than German debt of similar maturity)
  • €5 billion of 7-year bonds on March 29 at yield of 6.0% (310 basis
    points more than German debt of similar maturity, immediately
    traded underwater
    )
  • €390 million of 12-year bonds on March 30 at yield of 5.9% (auction
    effectively failed
    )

The next round of short term refinancing requirement consists of about
€12 billion in April and about €8.5 billion in May.

Market Reaction

While the initial reaction to the EU-IMF assistance announcement was
positive in the Greek government debt market and sovereign CDS market,
the optimism is receding. The yield on Greek 10-year bond dropped to
6.20% (spread of 305 basis points over German 10 year bond) on March 26
from 6.44% (spread of 337 basis points over German 10 year bond) on
March 22. However over the last three days, the yield is again trending
upwards and is trading at 6.52% on March 30 (spread of 343 basis points
over German 10 year bond). The 5 year Greek sovereign CDS spread dropped
to 295 basis points on March 26 from 341 basis points on March 22.
However, the same has been lately drifting up again and reached 333
basis points on March 30.

greek_spreads.png

Increased interest burden - According to the data compiled by
Bloomberg and Credit Agricole, Greece may pay about €13 billion more
in interest
on the debt it raises in 2010 than it would have if
yields had stayed at their pre-crisis levels relative to Germany's.
Interest on the three bonds it sold this year will amount to €7.7
billion over the life of the securities, compared with €3.8 billion if
they had sold them at the average extra yield, or spread, over German
debt that prevailed between 2000 and 2008, the data show. Greece will
incur a further €18.9 billion of interest on this year's remaining
issuance, compared with €9.4 billion before the crisis began.

We have (correctly) assumed such under our Greek public finances
projections of last month and have already built the increased interest
expense due to increased spreads against government expectations of
decline in interest rates. Subscribers, see Greece Public Finances
Projections
.I also recommends the Greek Banking
Fundamental Tear Sheet
for a list of affected banks and pro
subscribers should reference Banks exposed to
Central and Eastern Europe
.

greek_interest_expense.png

Conclusions - The sustainability of Greece's public finances is
seriously hindered by the piling government debt and widening fiscal
deficits which were a result of poor fiscal policies. While Greece has
announced drastic fiscal consolidation measures, serious concerns float
around the implementation (after which, they will still have to content
with internal deflation and increased social unrest). The Greek
government's loss of credibility in the markets is reflected in the
rising sovereign spreads and dwindling credit availability. Further,
Greece competes for funds with other distressed sovereigns scrabbling to
fund their fiscal deficits and refinancing requirements. Greece is
walking the tight rope of arranging funds from the market to sustain its
public finances and has one of the highest probabilities of failure.

Tied together with the common currency, the EU has been forced to
provide assistance to Greece. Although the assistance would be invoked
only when Greece fails to garner funds from the market, the implications
of the assistance package will be the increased contagion effect of
Greek's sovereign risk to other EU countries (some of which are already
struggling with their domestic issues). The EU nations will be forced to
accumulate debt on their books to finance Greece's requirements at a
time when EU nations debt are already approaching historical
proportions. Greece's rescue would send strong signals about how the
sovereign risk of a member can be perceived as the risk of the EU, which
has failed to maintain oversight and regulation of the members' public
finance policies and has become jointly responsible for the poor
governance in a member country
. Greece is not the only EU country in
trouble and the rescue can set a wrong precedent that can literally
redefine the concept of moral hazard in Euroland
! If this short term
solution to the Greek crisis is applied to other troubled nations,
sovereign debt accumulation in the region would be become a serious
concern that would haunt the region for many years to come. Germany and,
to a much lesser extent, France (as of very recently) have been,
therefore, resisting the idea of putting the entire burden of Greece's
rescue on EU and have proposed IMF collaboration.

EU-IMF assistance would entail a series of strong conditions for fiscal
consolidation through reduced public expenditure, increased taxation
etc. which will have deeper macro-economic impacts and undermine
economic recovery for Greece.

For the complete Pan-European Sovereign Debt Crisis series, see:

1. The
Coming Pan-European Sovereign Debt Crisis
- introduces the crisis
and identified it as a pan-European problem, not a localized one.

2. What
Country is Next in the Coming Pan-European Sovereign Debt Crisis?
-
illustrates the potential for the domino effect

3. The
Pan-European Sovereign Debt Crisis: If I Were to Short Any Country,
What Country Would That Be..
- attempts to illustrate the highly
interdependent weaknesses in Europe's sovereign nations can effect even
the perceived "stronger" nations.

4. The
Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western
European Countries

5. The
Depression is Already Here for Some Members of Europe, and It Just
Might Be Contagious!

6. The
Beginning of the Endgame is Coming???

7. I
Think It's Confirmed, Greece Will Be the First Domino to Fall

8. Smoking
Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer
Beware!

9. Financial
Contagion vs. Economic Contagion: Does the Market Underestimate the
Effects of the Latter?

10. "Greek
Crisis Is Over, Region Safe", Prodi Says - I say Liar, Liar, Pants on
Fire!

11. Germany
Finally Comes Out and Says, "We're Not Touching Greece" - Well, Sort
of...

12. The
Greece and the Greek Banks Get the Word "First" Etched on the Side of
Their Domino

13. As
I Warned Earlier, Latvian Government Collapses Exacerbating Financial
Crisis

14. Once
You Catch a Few EU Countries "Stretching the Truth", Why Should You
Trust the Rest?

15. Lies,
Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!

16. Ovebanked,
Underfunded, and Overly Optimistic: The New Face of Sovereign Europe

17. Moody's
Follows Suit Behind Our Analysis and Downgrades 4 Greek Banks

Premium Subscription research for the following sovereign states and
their respective domiciled banks at risk are available for immediate
download.

LATEST SOVEREIGN DEBT CRISIS SUBSCRIPTION CONTENT

Last modified on Thursday, 01 April 2010 00:00