Oh dear, Greece yet again

News reports this Sunday suggest that negotiations between Greece and its private sector bondholders on PSI have broken down yet again – apparently negotiations have been suspended, following renewed demands by the IMF/Germany, in particular, for a lower coupon (2.0% was reported by the FT) on new debt to be issued as part consideration for the cancellation of existing debt.

Assuming a notional haircut of 50% (65%+ in NPV terms) on some E200bn of existing debt held by the private sector, the IMF had (optimistically) forecast last October that Greek debt would remain around 120% by 2020. Since then, the IMF have leaked that their previous debt/equity projections were optimistic and that they will have to be revised higher – in particular, they cite that the Greek economy has deteriorated much further. The IMF and Germany are rightly concerned that the amount of the haircut currently proposed on private sector bondholders is insufficient to make Greece’s debt sustainable, a real problem for the IMF as it has to justify its continued participation in further bail out funds for Greece on the basis that the country’s debt will be sustainable – impossible given the current proposed “agreement”.

Last week, reports from official sources and bondholders suggested that a deal had been agreed – the situation has changed over the weekend. Negotiators from the IIF (who represent the majority of the private bondholders) have left Athens. Greece is quite happy to commit to a 4.0% coupon on the new bonds to be issued as part consideration for the the cancellation of the existing debt – they know that they will never meet their obligations and are only interested in accessing additional bail out funds, and ECB funding as long as possible. In addition, they realise that a default makes their banks, pension funds etc, etc totally insolvent. They will agree to anything on the basis that it sucks in the EU/Euro Zone/IMF further and postpones their inevitable default. Furthermore, the Greeks are just waiting for the outcome of the next elections (may be postponed from Spring to June this year), at which time the current opposition (who will win) claim that they will renegotiate current agreements – some hope.

The Euro Zone is adamant that it does not want to trigger CDS’s – hence this ludicrous “voluntary agreement”. However, I have to question whether this position is feasible for much longer.

It is alleged that certain Hedge Funds have built up a position in Greek debt, which enables them to block a potential deal and thereby profit from a hard default ie triggering CDS’s. The Greeks in response have threatened to enact legislation in respect of debt issued under Greek law, which (retrospectively) introduces Collective Action Clauses (“CAC’s”). These CAC’s would force minority bondholders to agree to the terms of a restructuring which have been agreed by a (to be specified) majority (by value) of bondholders. However, some of the relevant Greek debt is subject to UK law, which requires between 66% and 75% of bondholders (by value) to agree to a restructuring, for the deal to become binding on remaining bondholders. There is just not enough information to analyse the situation – in particular, the % of bonds held by the recalcitrant Hedge Funds is unknown – however, the kind of Hedge Fund’s that play this game are generally pretty sophisticated and, presumably, would not have gone into this without having a blocking percentage.

The Euro Zone Finance Ministers meet next Monday – a “voluntary” restructuring deal was supposed to be presented to these Ministers for them to sign off on and thereby enable the 2nd Greek bail out fund to come into force.

The time, effort and, in addition, vast sums of money wasted on Greece is a joke, indeed criminal. We all know that Greece will default – it is not an “if”, but a “when”.

Personally, I believe it would be much better to let Greece default (and certainly Portugal – Ireland may just make it, but its touch and go) and build a credible defence around the other Euro Zone countries, which are simply too big to fail. The EFSF/ESM lacks the resources for this task, unless the E500bn currently being discussed is leveraged up to a minimum of E2tr by the ECB, in my humble view. However, the ECB and Germany have rejected this idea – well great, but what’s your REALISTIC solution boys !!!!, other than the standard nonsense – the problem is that they have none. Euro Zone member states will not contribute more funds. The only other credible alternative is for the ECB to buy Euro Zone Sovereign debt.The above options have been and remain the only viable choices available, unless the Euro Zone wants a break up, which will be far, far costlier.

I am not sure how long this game can go on for – as you know, I have assumed no longer than the 1st Q of this year. However, I admit that the Euro Zone has dragged this whole sorry saga for longer than I would have thought possible.

The ECB’s unlimited 3 year LTRO (with much lower collateral requirements) has helped enormously and the next at the end of February is likely to be taken up by banks in size. That deals with banks liquidity issues over the next few years, even if a number of banks are effectively insolvent if they mark to market their assets – however, no one will propose that this occurs. Importantly, the ECB’s LTRO buys time for banks to recapitalise themselves, given the cheap and quite possibly even cheaper funding. Banks will, off course, have to write down the value of their bond holdings in the event of a restructuring and/or default, though most (ex Greek and Portuguese banks) should be able to cope with a restructuring/default of those countries – if it extends much beyond these countries, they really do have a problem.

However, the bottom line is that Euro Zone Sovereign debt problems remains and remains and …….No solution looks imminent.

Analysts believe that a deal will be reached between the Greeks and bondholders. Given the constant changes, who knows. However, a failure to reach an agreement in Greece (resulting in a default) will certainly negatively impact the markets as threats of contagion return (Portugal will be the next – it will certainly have to restructure its debt in any event), though the 3 year LTRO is a real game changer and, I suppose, future ECB LTRO’s could be extended to say 5 years or more, with the consequential positive impact on medium term Sovereign bond yields – as has been the case for short term Sovereign debt yields, following the recent 3 year LTRO.

However, I continue to believe that the ECB will ultimately be forced into a QE programme – probably dressed up as an anti deflation measure, as Euro Zone inflation falls below 2.0%. The ECB’s mandate is to maintain Euro Zone inflation “below, but close to 2.0%”. Furthermore, at his first meeting, Mario Draghi reduced rates by 25 bps on the basis of projections for inflation, which certainly differed from previous ECB practice, where interest rates were based on inflation levels prevailing at the time ie the ECB could move sooner rather than later. Euro Zone inflation is declining and will continue to decline – base effects make this a virtual certainty. As a result, I would argue that the ECB can introduce QE, whilst sticking to its mandate.

My friends at Credit Suisse estimate that QE, which should devalue the Euro, will result in 0.7% (real) improvement in Euro Zone GDP for every 10c reduction in the value of the Euro. Could sort out the otherwise (certain) recession in the Euro Zone this year.

Finally, don’t you just wish that Greece go away !!!.

Off to the wedding in the morning, so no blogs next week.

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