Articles - Update on Greek debt crisis


The French private sector bond rollover proposal

 Private sector involvement in a bailout

 The creditor countries (especially Germany and France) are determined to have private sector involvement in any second bailout of Greece. The problem remains that unless it is transparently voluntary it will be classified as a default and, therefore, trigger the derivative contracts (CDS). This could cause financial chaos within the Eurozone and beyond in a similar way to events that followed the demise of Lehman Brothers in September 2008.  

 Germany, which is under most internal pressure to make private creditors share some of the burden of a potential restructuring of Greek debt, previously suggested that the duration of Greek bonds maturing over the next two years should be extended by seven years. However, this would undoubtedly lead to a default, even if it was done on a ‘voluntary' basis, because creditors would suffer a significant reduction in the net present value of their bond holdings. Furthermore, the rating agencies have publically stated as much. Subsequently, Germany has conceded that this is a non-runner and recognised the necessity of finding a solution that includes private sector participation, so the whole burden does not fall on the taxpayer, while avoiding a default.

   This is a difficult, perhaps impossible conundrum to resolve and is contributing to the procrastination and uncertainty over the destiny of the Greek debt problem. However, an alternative proposal has emerged from the French banking sector in the last couple of days that could, perhaps, bridge these apparently conflicting objectives and provide a neat compromise to form the basis of a second bailout.     The French bond-rollover plan The essence of the French banks' proposal is as follows:  

     
  •   For the bonds maturing in 2012, 2013 and 2014 to exchange 50% of their value for new Greek bonds with 30 years' maturity.
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  •   A further 20% of the value to be invested in a guaranteed fund of new AAA bonds that would have a 0% coupon where the interest would be deferred. The fund would be a special purpose vehicle (SPV) guaranteed by a European financial body (most likely the EFSF and its successor the ESM) to act as a form of insurance in the event that Greece did default.
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  •   The remaining 30% would be repaid to the creditors on the due date of maturity of the respective bonds.

 It is a variation of the Brady bond swap that was used successfully in the 1980s in Latin America with countries such as Argentina, Brazil and Mexico. In fact, it has been described as a ‘sort of private Brady bond scheme without a public guarantee'.    

 Will the French proposal work where the German scheme foundered?

 One note I read this morning commented that the plan had 'more holes than a slice of Swiss cheese'. While this may be a bit harsh, there are some obvious weaknesses in the proposal and it will have to modified if it is to be used as the model for private sector participation in the future restructuring of Eurozone debt.   The obstacles to overcome are:  

     
  •   The details of the proposal have been drafted with the French government and banking sector (and by implication other countries with significant exposure to Greek debt) in mind, and not Greece itself. The analogy to the successful Brady bond scheme is mendacious and fallacious. The key difference is that Brady bonds imposed a haircut on the creditors that were lending to the Latin American countries. It was recognition that these were bad or deteriorating loans and some write-down in value was appropriate. Despite the fact that the same scenario now confronts the creditors to Greece, the French proposal still refuses to acknowledge it. Indeed, as one might expect as the plan has been devised by the French banks, it is irresistibly attractive to the private sector creditors as most of the bonds due to mature over the next three years are trading well below par and, under the proposal, they will be receiving 100 cents in the Euro for swapping for new bonds.
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  •   Just as the plan favours the private sector creditors, it is unattractive to Greece. In theory, they could buy back bonds in the open market at a 45% discount now for cancellation that would ease the debt burden. With the French plan the discount is being replaced by new bonds issued at par.
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  •   It is not yet clear who is included in the plan. The objective of it is to reduce the sum needed for the bailout by around €30bn, but much is held domestically in Greece and by the ECB. Furthermore, private institutions (e.g. pension funds), hedge funds and other private investors are also sizeable holders. Are they being included or not in the proposal? If not it will be almost impossible to attain the target of €30bn through private sector participation.
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  •   It is also not certain whether or not this would constitute a ‘credit event' and be classified as a technical default. No rational private sector investor would want to rollover its Greek bonds if the alternative was to be repaid on maturity and remove the risk of a haircut once and for all. Therefore, it cannot be wholly voluntary and there is a degree of moral suasion going on for the better good of the Eurozone and, especially its banks with huge exposure to periphery debt.
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  •   The interest rate payable on the new 30-year bonds has also not been finalised. This is important because if it is above the current average of outstanding Greek debt over the next three years (5.15%) then it will worsen the solvency profile of the Greek public sector finances. One report stated the expected rate was 5.5%, in which case it defeats the object of providing debt relief to Greece.
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  •   The new AAA bonds in the SPV would also require an enhanced yield if they were to provide insurance against the eventuality of default. The problem is that yields on AAA debt, such as German bunds, are well below those that would be necessary. If Greece defaulted, creditors could expect to lose at least 50% of the value of the bonds and therefore it is clear a high coupon would be required.

 Conclusion This is a seductive and outwardly attractive proposal that cleverly cites the success of the Brady bond scheme as a similar precedent. As the above shortcomings make clear, the reality is very different; the plan was devised by the most vulnerable creditors with their own interests at the forefront (as well as Sarkozy's election next year). The troika and Greek politicians would be ill advised to adopt this proposal without considerable modification.

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