Do I See Movement In The Greek Trenches?

This isn’t about economics anymore, this is now about who does what, and when, and how everyone else reacts.

Certainly the news that Greek bonds hit another post-EMU record high yesterday can hardly be said to have come as a surprise. 10-year bond yields reached 7.76 per cent at one point and closed up 26 basis points on the day. This morning Greece comfortably sold 1.5 billion euros worth of 3 month Treasury Bills – in the end they sold 1.95 billion euros of them – but the yield on the bonds more than doubled to 3.65 percent, from 1.67 percent for a sale of similar debt on January 19. And the the extra yield investors demand to hold Greek 10-year bonds instead of German bunds, the euro-region’s benchmark government securities, rose again today – to as much as 472 basis points – the most since Bloomberg records began in 1998. The average spread over the past 10 years has been 61 basis points. Greek two-year notes also fell, pushing the yield 23 basis points higher to 7.51 percent.

On the other hand, Bundesbank President Axel Weber was out there yesterday telling a group of German lawmakers that Greece was going to need more, not less money.

Greece may require financial assistance of as much as €80 billion ($107.92 billion) to escape its debt crisis and avoid default, Bundesbank President Axel Weber told a group of German lawmakers Monday, according to a person familiar with the matter.

The estimate, considerably more than the €45 billion that European countries and the International Monetary Fund are currently prepared to extend Greece this year if it needs a bailout, suggests that a rescue of the country may come in several stages and reach beyond 2010.

Why, I ask myself, is a conservative, and normally discreet, figure like Axel Weber out there stressing precisely this point at this moment in time, when German voters are notably nervous about any sort of aid to Greece, reticence on the part of Angela Merkel’s coalition partner makes a parliamentary debate on a loan difficult, and voices are even being raised about whether it would not be a better idea for Germany simply to put the losses down to experience and go back to the Deutsche mark?

Germany might consider exiting Europe’s current monetary union to create a smaller bloc as the Greek crisis threatens to turn the euro area into a region of “fiscal profligacy,” Morgan Stanley said.

Greek rescue measures “set a bad precedent for other euro- area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time,” said Joachim Fels, co-chief global economist at Morgan Stanley in London, in an April 14 note. “If so, countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union.”

All these statements can be read as bargaining postures, attempts to get people in the South of Europe to focus their minds on the problem in hand, but they can also be read as warnings of what could happen if they do not.

Certainly, nothing at this point is very clear. Especially, as the FT reminds us this morning, when we live in a world where the unthinkable has finally become thinkable. So we could now ask ourselves whether the financial markets are not in fact, and before our very eyes, gearing themselves up for an event which many had not previously been factored into the realms of the possible: Greek debt restructuring.

Even as Greek bail-out discussions continue – talks between representatives of the European Commission, European Central Bank and IMF were delayed on Monday by the volcanic ash cloud – market watchers are starting to question whether, in the long term, Greece can avoid a restructuring of its debts or even an outright default.

“Investors and analysts are now running the numbers to see what a haircut to Greek bonds would be,” says Steven Major, global head of fixed income research at HSBC. “One way to do this is to compare restructurings for emerging market sovereigns. Based on the defaults over the last 12 years the average long-term recovery rate is close to 70 per cent. Ultra-long Greek bonds currently trade at a price below this.”

The Financial Times also reports that the IMF is likely to raise the question of debt restructuring at their forcoming meetings with the Greek finance ministry – you know, the ones that have been delayed by the symbolic intervention of all that volcanic ash. According to the FT source it is not likely to be a detailed discussion “just a pointed reminder of the debt forecast”.

The IMF has already told the finance ministry informally that Greece’s debt will reach 150 per cent of GDP by 2014, according to this person. Greece’s debt to GDP level – 113 per cent in 2009 – is already the highest in the eurozone. The IMF calculates that Greece will need to find €120bn ($162bn) over the next three years.

Of course, the term “debt restructuring” does sound a lot better than default, and the expression does cover a wide range of possible outcomes, running from unilaterally changing the terms of the bonds one the one hand, to voluntary renegotiation to ease refinancing pressure at the other.

One proposal which has been advanced (most recently by Wolfgang Munchau) is for recourse to some form of Brady bond:

Restructuring is a form of default, except that it is by agreement. It could imply a haircut – an agreed reduction in the value of the outstanding cashflows for bond holders. The Brady bonds of the late 1980s, named after Nicholas Brady, a former US Treasury secretary, worked on a similar principle. An alternative to restructuring would be a debt rescheduling, whereby short and medium-term debt is converted into long-term debt. This would push the significant debt rollover costs to well beyond the adjustment period.

Brady bonds were initially issued to ease the debt difficulties of a number of Latin American countries in the late 1980s (and they are modeled on the earlier Japanese par bonds – you can read more about them in wikipedia here). The essential idea in the Greek case would be that current debt instruments would need to be swapped for some longer term bond with a lower than market rate coupon (or implied interest rate).

Of course, as Munchau points out, in order to get the existing bondholders to trade their debt on a voluntary basis, they would have to be put under some sort of pressure:

One way to force the debate would be to attach super-senior status to the EU loan to Greece. I understand this is still an unresolved issue. Super-senior means this loan would be repaid before existing debt. Should Greece ever get into a liquidity squeeze, bondholders would be put in a back seat. In such a situation, they might prefer rescheduling.

Which makes this little detail about the form of the EU loan rather more interesting than it might seem at first sight:

Any aid to Greece would come in the form of pooled loans from the euro-zone countries and not the purchase of Greek bonds, German Deputy Finance Minister Joerg Asmussen said Tuesday.

He also said that Greece will be an issue at the meetings of finance ministers and central bankers from the Group of Seven leading industrial nations and the Group of 20 industrial and developing nations this weekend in Washington.

“Of course, Greece will be an issue,” Asmussen told reporters Wednesday. He also said that “if financial aid for Greece will be given, then the pursued path will be to provide pooled loans.” Germany would provide its share of such loans through the state-owned KfW Banking Group and the loans would be guaranteed by the government.

Plans to purchase bonds “is off the table,” he said. The advantage of providing pooled loans is that there can be stricter conditions to paying out such loans, such as demanding the implementation of fiscal reforms.

So we could imagine that the forthcoming loan would have super-senior status (German voters would settle for nothing less), and, if this interpretation is correct, it will be existing bondholders, and not the EU governments, who will be being invited to “bail Greece out”. Well, maybe we won’t have to wait too much longer to find out, since the Greek Finance Minister George Papaconstantinou stated today that the country could call on loan backup from the EU and the IMF by as early as next month depending on loan conditions and the progress of talks with the EU, ECB and IMF joint mission, which is composed of around 20 people according to reports. Plenty to talk about, and plenty of people to do the talking. Too many, perhaps?

This entry was posted in A Fistful Of Euros, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

12 thoughts on “Do I See Movement In The Greek Trenches?

  1. Hello Edward, First, thanks for the great blogging. Next, re your latest post, I would just add that no matter if EU governments have super senior status for their loans or not, what’s important is who finally has to pay (Obama would say: “where the buck stops”). And I have read a couple of times, without being able to find a website with the actual data, that major holders of Greek public debt are German, French and Swiss private banks. If these banks are “non-senior” creditors, in the event of a restructuring they will be left to suffer the losses. But, given the fragility of their balance sheets and the “systemic” threat that this could pose, governments would finally still step in to bail them out. Result: the bill will be footed by taxpayers in Germany, France, Switzerland, etc. Regards!

  2. Quick question – where is the best place to look up bond yields and spreads, which is accessible to everyone?

    The Economist had a piece giving estimates for the debt held by banks of various nations, and spelling out the methodology by which they came up with the numbers(no-one has concrete figures) –

    Thanks for the very interesting posts.

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  5. ” Greece may require financial assistance of as much as €80 billion ($107.92 billion) to escape its debt crisis and avoid default, Bundesbank President Axel Weber told a group of German lawmakers Monday, according to a person familiar with the matter.

    The estimate, considerably more than the €45 billion that European countries and the International Monetary Fund are currently prepared to extend Greece this year if it needs a bailout, suggests that a rescue of the country may come in several stages and reach beyond 2010.”


    I thought everyone already knew this? That any “support” will have to be multi-year and that 45 large is only the first year downpayment?

    Surely everyone does know that, yes?

  6. A “super senior” loan of significant size (like 80 billion) would completely smash the value of Greek Government bonds, as the expected recovery will go from 50% to 0% ! Expect also wild movements in “fringy” countries like Portugal.

    Give it a little more time and an “exit” of Germany from the Euro will rise to the status of “Plan A”. How it is implemeted without jeopardizing the Union is the big question now (Martin Wolf recently put it on his blog). I already left my attempt for an answer here : .

  7. Tim Worstall asks:

    “Eh? I thought everyone already knew this? That any “support” will have to be multi-year and that 45 large is only the first year downpayment? Surely everyone does know that, yes?”

    Weber’s numbers are indeed nothing new, so I also don’t understand the hoopla surrounding his statement.

    When the bailout plan was originally announced on April 12-13, it was reported in the Greek press (Kathimerini and others) that the aid would be as follows:
    1. For 2010, 40-45 billion euros, with 30 billion euros coming as bilateral loans from Eurozone countries and another 10-15 billion from the IMF.
    2. For 2011-2012, an additional similar amount, with the 40 billion euros number explicitly mentioned.
    Adding the 2010 and 2011-2012 numbers comes awfully close to the 80 billion mentioned by Weber. Whether even the 80 billion is enough and to what end would be a different question.

    Weber seems to have just reminded people of the original plan. Reuters also had reported that the plan included the 40-45 billion for 2010, and that additional funds would be provided for 2011-2012.


  8. Edward, thanks for this paper. It is quite a u-turn from the Germans. The amount of Greek debt in Germany banks might have played a role, along with the arithmetic quasi-impossibility for Greece to pay the enormous sums that are expected in the coming years. What cannot be paid will not be paid, and an organized default is certainly better than an exploding kettle.

    Thus the first unthinkable is being considered. Next on the unthinkable list:

    – Debt restructuring would help solving one of the two problems of Greece. The other – membership of the Euro – remains intact. How will Greece restore its competitivity within the EMU? (The idea of a 20 – 30 % internal devaluation is not exactly unthinkable, but rather downright silly).

    – Noises of debt restructuring tend to be self-fulfilling as the bond markets respond by sending interest rates to unsupportable levels. After Greece, who would be next?

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