Greece: Let's try again

The latest iteration of the Greek saga offers little relief, except perhaps time.  It would however limit the participating banks’ losses to a maximum of 50%. 

 French banks have proposed a plan which apparently will be approved by German banks.   While its details have not been fully revealed, it would cover the maturities of Greek public debt held by banks and falling between 2011 and 2014 or around €60 billion. 

Under this plan, the most likely alternative would be for banks receiving €100 in repayments to keep €30.  The remaining €70 would be rolled into a 30 year Greek bond.  Greece would need to come up with €20 to buy AAA-rated zero-coupon bonds to be used as collateralize ensuring that, a maturity, the principal of the new 30 year Greek bonds will be repaid in full.

Since the participating banks keep €30 upfront, and since the present value of the collateral for the new bonds is €20, they insure that they will recover no less than 50%.

For the Greeks, the deal is less appealing.  They need to finance the 30% repayment, i.e. some €18 billion, and they need to buy the AAA zero-coupon bonds, i.e. another €12 billion.  In other words, Greece gets no reduction in debt.  Indeed, should its economic recovery materialize, the interest on its new bonds will go up.

The EU will likely have to come up with most of the 30 billion that Greece needs, getting it ever more committed to a successful rescue and more exposed to losses should a messy default become unavoidable.

What this plan does is buy time, time to set up the conditions for a more competitive Greek economy.  These would include less constraining labor laws, well thought out privatizations, pension reform, to name some key ones.  But does the plan incenticize the parties and is the burden sharing appropriate?

Some of the proponents of the plan have likened it to the Latin American Brady Plan.  Yes, the Brady bonds that were issued benefitted from rolling coupons guarantees and/or collateralized principal.  But unlike the Greek plan, they imposed ‘haircuts on the creditors.  Here, European taxpayers are picking up the tab.

Another area of concern is how “voluntary” the exchange of maturing bonds for new 30 year bonds will be viewed by rating agencies and the market.  Newspapers have reported informal contacts between European officials and rating agencies, whereby the former were appearing to warn the latter against ruling the exchange as a default.

I think it is fair to say that, if creditors were offered the chance to be repaid in full, they would jump at it.  If rating agencies stand firm, this plan will not work.  If they don’t, the European CDS market will likely be destroyed.  Would it be worth it?

Greece needs a debt reduction of at least 50% accompanied by a credible plan to improve its public finances and facilitate economic growth over time.  To that end, finding time is necessary, but it is not sufficient.

It is possible that the EU will reveal such a plan, but so far it has not and the latest effort is increasing, not decreasing the burden of the debt.