Friday, March 26, 2010

Will the Greek safety net work?

The EU/IMF "safety net" for Greece is intended to make it possible for Greece to refinance its maturing bonds and thus preempt the need for the net to be drawn upon. While it is too soon to judge whether this maneuver will satisfy the bond market, so far it hasn't. 

Much will depend on the scale of the package in relation to the Greek debt calendar. It is very unlikely that the package will be equal in size to Greece's maturing debt in 2010-11. The package is said to be about EUR25 billion, while the Economist estimates that Greece needs at least EUR75 billion. 

Any rescue requires the unanimous consent of all 27 EU members, which is not a given.

Greece needs its spreads to come in by at least 200bps; so far it has tightened by ~20bps.
The ECB has relaxed its collateral eligibility requirements for 2010-11, so that Greek bonds would still be eligible for discount in the event of a ratings downgrade by Moody's. The ECB has not revealed the amount of Greek debt that it has taken as collateral (or owns outright), and may come under pressure to do so.
A larger question is whether risk managers will continue to tolerate large exposures to Greece, or will reduce concentration limits on all things Greek. I can't imagine that this is not happening globally. 

The things to look for over the next months are:
  • The scale of the package
  • Political developments in Greece
  • Greek fiscal performance
  • Bond and swap spreads

Tuesday, March 23, 2010

The no-bailout clause of the Lisbon Treaty

Article 125 of the Lisbon Treaty (2007):

  • The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. 
  • A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.

Germany sets conditions for Greek rescue

Berlin has indicated what conditions it would require to participate in a Greek rescue. Germany as come under a lot of pressure to come to Greece's aid, while facing huge opposition at home. It appears that Merkel's solution is to agree to consider aid while setting impossible conditions. There is simply no way that the EU treaty can be renegotiated at all, let alone quickly.

From today's FT:
A senior government official in Berlin said there would be no agreement at this week’s EU summit on a specific rescue package for the debt-strapped Greek government. If there were to be agreement on a “mechanism” to provide such assistance, he said, it could only be triggered once Greece had exhausted its capacity to raise money on the international capital markets; the IMF had agreed to make a “substantial contribution” to a rescue package; and the EU members had agreed to negotiate new rules to prevent any reccurrence of such a debt crisis. The German demand that could meet the most resistance from its EU partners is the insistence that new rules to enforce budget discipline should be negotiated, even if that requires treaty changes. Both France and the UK are passionately opposed to any such suggestion of reopening treaty negotiations.

So it would appear that Berlin's conditions are impossible. This does not mean that Greece will ultimately be allowed to default, but it does suggest that a swift and harmonious rescue will be difficult to achieve.

Saturday, March 6, 2010

Greece 1898

From today's NYT:
The year after Greece lost another war against the Ottomans, Germany joined five other European powers in imposing the International Financial Commission on Greece in 1898. The commission controlled customs duties at ports including Piraeus and Corfu; state monopolies for products such as kerosene, matches and playing cards; and duties on stamps and tobacco consumption, all to ensure that Greece continued repaying its loans.

Those were the days. That was when "conditionality" really meant something.

Thursday, March 4, 2010

Greece bond sale a success

Well, much to my surprise the Greek bond sale was oversubscribed (albeit at a high yield of >6%). This seems to me to bring the crisis from a boil to a simmer. It is not clear to what the success of the deal is attributable.

Possible reasons are: (1) markets find the austerity package to be credible; (2) markets think the package is credible enough to allow Greece to be rescued; or (3) markets have concluded that, willy-nilly, Greece won't default.

It appears that Prime Minister Papandreou believes that the answer is #2: that the package is credible and therefore merits European help.

Here is what he said today:
Let me be absolutely clear: Greece is not asking for a penny from German taxpayers. We are asking for political support, not financial aid. Currently, Greece has to borrow at interest rates almost twice as high as Germany and other EU countries. Greece must be able to borrow at rates that are not as prohibitively high. Otherwise we will have a difficult time implementing our tough austerity measures. My government is determined to overcome the huge credibility and budget deficit that we inherited.

His view is that market access is not enough; Greece needs market access at reasonable rates. He's undoubtedly correct: Greece's interest burden is too high already without high-yield credit spreads on top of it.

So the ball would now seem to be squarely in Merkel's lap. Reports are that the Germans and the French have a plan in mind, but want to wait at least a few weeks so that (1) the Greeks actually implement their plan, and (2) German public opinion can be brought around.

Papandreou is still in total denial about who caused this crisis: it's not the deadbeat looking for a guarantee, it's the debt markets:
Greece is being attacked by speculators who are putting the entire European project at risk. We need greater coordination and better regulation in order to protect our monetary union from speculation. Greece is the latest--but surely not the last--casualty of leaving financial markets unregulated. While Greek pensioners and civil servants are asked to accept drastic pay cuts, speculators are making billions every day on the back of Greece's problems. This is not about politics, this is about profits.

Wednesday, March 3, 2010

The Merkel plan won't work

Let's assume that Germany and France can cobble together a support package for Greece. A few eurozone governments will direct their state banks (such as KfW) to guarantee Greek government bonds, which would then be AAA and readily marketable. Sort of a Fannie Mae for Greece.

In theory, this will get Greece over the hump and buy time for it to bring its fiscal deficit under control. Then Greece would be able to access the debt markets on its own and maybe even refinance the guaranteed bonds.

I just don't see how this can succeed in the long run.

One, Greece's expense and revenue trajectories are such that only a deep and sustained depression can bring them into balance, which is politically impossible. (Greece will balance its budget only when it can no longer borrow.)

Two, Greece will not be able to return to the private debt markets anytime soon.

Three, this means that the EU (really the EZ) will have to finance not only Greece's deficits into the foreseeable future, but will also have to refinance maturing debt, until finally all of Greece's debt has been guaranteed by the EZ.

Fourth, the political will in Germany to engage in anything like this is very low.

My prediction is this:

The Merkel manoeuvre succeeds in preventing a crisis at this time.

By the fall, it becomes clear that Greece cannot implement an adequate austerity plan to satisfy the markets or the rating agencies.

Rating downgrades render Greek government bonds ineligible for discount at the ECB and toxic in the debt markets.

Europe would then be confronted with the choice of default or full responsibility for Greek finances (and funding needs).