Intra-Europe capital flight that has taken place over the past couple of months has made the prospective Greek workout (debt rescheduling) plan so ludicrously profitable for speculators and outrageously expensive for euro-area taxpayers, that I believe a justified fear of public anger will force its reworking. At the same time, the prospect of further capital flight if no Greek deal is reached by the end of the year has become so dangerous that a reworked plan will have to be agreed within a short window of time.
The current problems were created by the eurocrats having only a sketchy understanding of how “Brady bond” exchange offers work, and how they have to mesh with market dynamics. The eurocrats could have delegated the work to people with experience at rescheduling sovereign debt, but wanted to keep the control and credit for themselves. Bad call.
For several weeks now, I’ve been hearing hedge fund people talk about how “private sector involvement”, or the proposed exchange offer for Greek state bonds, is a “no brainer”. As they saw it, an investor should buy Greek government bonds, say a 10-year issue, at current market prices, wait the month or two for the exchange offer to be fully documented and formally proposed, and then exchange the bonds for the new paper.
The deal is a “no brainer”, the hedgie will say, because the zero coupon bond that is offered as collateral for the deal will more than cover the cost of buying the bond. So you are getting a bond for free. Well, not free for the euro-area taxpayers who are guaranteeing the European Financial Stability Facility that is putting up the cash to buy the zeros.
For example, late last week Hellenic Republic 10-year bonds were being bid for at about 39 cents on the euro, and offered for sale at about 43 cents on the euro. At the same time, the value of the German zero coupon bund was about in the middle of that range.
One of the original Brady plan architects told me: “What made the Brady deals [for distressed emerging markets] possible was that you were dealing with an interest rate environment of say 8 to 9 per cent, or even higher. So the US Treasury 30-year zero coupon bonds that were offered as collateral for the principal payments would cost between 15 and 20 cents. With interest rates at the low levels we have now, the cost of a zero is over 40 cents. It was madness ever to think that in today’s world you could structure a deal à la Brady. It amounts to a prepayment of nearly half the debt stock you are restructuring.”
To be fair, that prepayment was only an absurd 32 cents on the euro, back when the Greek support package was agreed on July 21. Since then, the capital flight out of the euro-area periphery into German bonds has raised the cost of the collateral by more than a quarter.
So the speculators, hedge fund operators and so on who were supposed to be the target for haircuts are being offered a large, risk-free profit. Unless, of course, the deal is changed, or, using the current term, “recalibrated” to make it less profitable, and cheaper for the euro area taxpayers who are underwriting the EFSF.
If it were only a question of taking money away from a gang of evil Anglo Saxon speculators, this “recalibration” would already have been privately agreed among the eurocracy and political leadership. However, the recalibration would also affect those core euro area banks, particularly in France, and their friends at the European Central Bank.
Even though the German government’s leadership is incensed at how the terms have moved against them, they are reluctant, for now, to insist the deal be re-opened.
However, they are likely to raise their voices once the last (presumably Slovakian) vote has been taken, and the EFSF approved. Then, as the arithmetic of the current deal becomes better understood among the voters, it would be reasonable to bet that the bondholders’ nominal haircut will be increased, probably to a nominal 50 cents on the euro.
Why should we have any confidence that a deal can be done this year, given how badly the Greek support package has been handled? Since most of the public thinks a default has already taken place, would there really be that much of a shock from a “hard default”, as distinct from a negotiated exchange offer?
Yes. It’s not the write-offs of Greek state debt as such that would be the problem, but the possible consequences to the stability of the euro area payments system. If the Greek government does not have the cash to pay for essential services as well as debt service, say in December, then it might have to resort to its powers under Article 65 of the latest version of the European treaty. Those allow for limits on the otherwise free movement of capital for the purposes of taxation, or “supervision of financial institutions”, as well as “public policy or public security”.
Could those include restrictions on bank withdrawals or transfers? What effect would those have on the psychology of depositors elsewhere in peripheral Europe? I don’t know anyone who wants to find out the answer to those questions, especially those who are already quietly discussing them.
So yes, I think a deal will be done, on tougher terms for the bondholders
www.ft.com
The current problems were created by the eurocrats having only a sketchy understanding of how “Brady bond” exchange offers work, and how they have to mesh with market dynamics. The eurocrats could have delegated the work to people with experience at rescheduling sovereign debt, but wanted to keep the control and credit for themselves. Bad call.
The deal is a “no brainer”, the hedgie will say, because the zero coupon bond that is offered as collateral for the deal will more than cover the cost of buying the bond. So you are getting a bond for free. Well, not free for the euro-area taxpayers who are guaranteeing the European Financial Stability Facility that is putting up the cash to buy the zeros.
For example, late last week Hellenic Republic 10-year bonds were being bid for at about 39 cents on the euro, and offered for sale at about 43 cents on the euro. At the same time, the value of the German zero coupon bund was about in the middle of that range.
One of the original Brady plan architects told me: “What made the Brady deals [for distressed emerging markets] possible was that you were dealing with an interest rate environment of say 8 to 9 per cent, or even higher. So the US Treasury 30-year zero coupon bonds that were offered as collateral for the principal payments would cost between 15 and 20 cents. With interest rates at the low levels we have now, the cost of a zero is over 40 cents. It was madness ever to think that in today’s world you could structure a deal à la Brady. It amounts to a prepayment of nearly half the debt stock you are restructuring.”
To be fair, that prepayment was only an absurd 32 cents on the euro, back when the Greek support package was agreed on July 21. Since then, the capital flight out of the euro-area periphery into German bonds has raised the cost of the collateral by more than a quarter.
So the speculators, hedge fund operators and so on who were supposed to be the target for haircuts are being offered a large, risk-free profit. Unless, of course, the deal is changed, or, using the current term, “recalibrated” to make it less profitable, and cheaper for the euro area taxpayers who are underwriting the EFSF.
If it were only a question of taking money away from a gang of evil Anglo Saxon speculators, this “recalibration” would already have been privately agreed among the eurocracy and political leadership. However, the recalibration would also affect those core euro area banks, particularly in France, and their friends at the European Central Bank.
Even though the German government’s leadership is incensed at how the terms have moved against them, they are reluctant, for now, to insist the deal be re-opened.
However, they are likely to raise their voices once the last (presumably Slovakian) vote has been taken, and the EFSF approved. Then, as the arithmetic of the current deal becomes better understood among the voters, it would be reasonable to bet that the bondholders’ nominal haircut will be increased, probably to a nominal 50 cents on the euro.
Why should we have any confidence that a deal can be done this year, given how badly the Greek support package has been handled? Since most of the public thinks a default has already taken place, would there really be that much of a shock from a “hard default”, as distinct from a negotiated exchange offer?
Yes. It’s not the write-offs of Greek state debt as such that would be the problem, but the possible consequences to the stability of the euro area payments system. If the Greek government does not have the cash to pay for essential services as well as debt service, say in December, then it might have to resort to its powers under Article 65 of the latest version of the European treaty. Those allow for limits on the otherwise free movement of capital for the purposes of taxation, or “supervision of financial institutions”, as well as “public policy or public security”.
Could those include restrictions on bank withdrawals or transfers? What effect would those have on the psychology of depositors elsewhere in peripheral Europe? I don’t know anyone who wants to find out the answer to those questions, especially those who are already quietly discussing them.
So yes, I think a deal will be done, on tougher terms for the bondholders
www.ft.com
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