Tuesday, February 21, 2012

Nanny Mcphee Runs Greece?

You'll read hundreds of viewpoints on the second Greek bailout but will cover the key points below. Andreas Koutras reports, Nanny Mcphee runs Greece:
Finally the baby is born and the parents need a good nanny as they are too busy squabbling and fighting with each other. Fortunately, the local Commission had Nanny Mcphee free. As in the movie her purpose is to teach some (fiscal) discipline, show who is the boss and set the rules in the household.

Eurogroup agreed on the 2nd Greek bailout/restructuring of Greek debt. The main points are:
  1. Haircut on the nominal has increased from 50% to 53.5%
  2. Significantly there is NO mention on a “voluntary” PSI. The word has disappeared from the text of this Eurogroup pointing to shifting intentions.
  3. Eurogroup accepts that the ECB and the NCB purchases are held for public policy purposes. The gains may be given to back to Greece. The statement does not say whether the SMP gains would be passed in the form of a loan or gratis. The NCB gains would however be passed back.
  4. There would be closer on-site monitoring by the commission on Greece. In other words, Greece would have Nanny Mcphee for the next few years “…ensuring the timely and full implementation of the programme.”
  5. A segregated account where Greece is going to pay the next quarter’s debt would be created.
  6. A constitutional change giving priority of payments to Greek debt. Reactions to this would be interesting to watch. I guess that it would not be taken lightly by many political parties back in Greece.
  7. Eurogroup is aware that more sacrifices would be needed by the Greek people.
  8. The interest rate would be lowered to 150bp on the Greek Loan Facility
  9. The IMF is expected to make a significant contribution till 2014
The aim of the exercise is to reduce the Greek debt to 120.5% by 2020 with the Commission running the Greek state (“…strengthening of Greece’s institutional capacity.”) for the next few years.

I remain sceptical if this can really be done efficiently and also if the program can succeed. However, if the Greeks show an appropriate level of compliance then Europe promises not to abandon Greece. Eurogroup also accepted the wrong logic that the ECB is a preferred bondholder. The bond market may start repricing this risk. This development as we have pointed out before is important and it would give rise to many problems and possibly litigations in the future.

Conclusion
This new bailout although it apparently increases the financial help and sustainability of Greece it also increases the political risk of non-compliance and resentment. The greatest fear is that many would see the running of the country as national humiliation and a rallying point for anti-European forces. In the movie the unruly children start respecting the Nanny and finally accept her as a friend. This is however, a fictional happy ending that has low chances of success in Greece.
Andreas also went over some of the details of the new PSI bonds that were published today:
Bond holders that tender their holdings to the PSI voluntary will get 15% in cash and 31.5% in new bonds with the following terms:
Coupon:
  • Y1-3: 2.0%
  • Y4-8: 3.0%
  • Y9-20: 4.3%
  • The bond will be amortized by 5% from Y11 to Y20.
Valuation: Assuming that the exit discount yield is 12% then the value of the package is 26.9% while with 9% exit yield this 31.9%. At 5% exit yield the value is 34.5%.

GDP warrants: The securities would also have detachable GDP warrants. We do not know the thresholds but we can assume that they are the ones that the Troika assumed in their debt analysis. We do not assign great value to these warrants since the rate is capped at 1%. The maximum payoff of these warrants has 12% value at 9% exit yield. Thus one cannot assign more than 2-3% present value to these warrants.

Legal:
New bonds and warrants would be under English law with all the bells and whistles like Negative Pledge, CAC.

Interestingly both the EFSF and the bonds would have the same Paying Agent and payments would mirror the EFSF loan. I guess this was done in order to avoid paying one and not another bondholder in the case of a further default.

CAC and ECB
The Eurogroup agreement allows for the non-SMP holdings to pass their profits to the Greek state by effectively lowering the interest rate payments. If this is so then the question arises:
  • Did the Republic swap the holdings of the SMP and the holdings of the NCB investment portfolio?
  • If they did then this is a gross violation as it implies some common bondholders were saved even though they did not buy the bonds for “monetary purposes”.
  • If they did not swap then either they are not going to participate in the PSI and the CAC’s will not be activated or they expect to suffer a haircut too.
My guess is that they were swapped and in this case they should expect litigation to fly.
Most market participants share Andreas' skepticism. Bloomberg reports, Greek Rescue Leaves Europe Default Risk Alive:
Europe is still struggling to avoid the threat of default as investors warned Greece will soon risk violating the terms of its second bailout in three years.

Seven months of negotiations ended in the pre-dawn hours in Brussels with Greece winning 130 billion euros ($172 billion) in aid it needs to avoid a March bankruptcy. Any respite may prove temporary after it signed up to a program of austerity and economic reform aimed at slashing debt to 120.5 percent of gross domestic product by 2020 from about 160 percent last year.

Even with investors and central bankers chipping in to relieve the debt burden, economists from Citigroup Inc. to Commerzbank AG concluded Greece may again fail to deliver amid a fifth year of recession, looming elections and social unrest. The upshot could be the removal of aid and renewed debate over the merits of fresh assistance before year-end as policy makers shift toward doing more to inoculate the rest of Europe from contagion.

“The bailout bandage is on, but it won’t take much to unravel,” said David Miller, partner at Cheviot Asset Management in London. “The euro zone has done its best to ensure that Greece will deliver on promises, but there is considerable scope for backtracking on deficit reduction.”

Financial markets signaled doubt the accord will fix Greece’s travails permanently or spell an end to the two-year debt crisis. The euro surrendered initial gains against the dollar and European stocks fell from a six-month high.

Bankruptcy Risks

By supporting Greece, Europe’s high command chose the financial and political cost of awarding fresh money over the risk of a bankruptcy that could splinter the 13-year-old euro area. At least 386 billion euros has now been committed to save Greece, Ireland and Portugal with investors predicting the government in Lisbon at least will need more support.

To tackle future fiscal emergencies and limit contagion, officials held out the prospect of boosting their firewall to 750 billion euros from a planned limit of 500 billion euros when a permanent aid fund is paired with the temporary facility starting in July. They also cajoled investors into providing more debt relief in an exchange meant to tide Greece past a March bond repayment.

In return for the new cash, Greece signed up to cuts in pensions, the minimum wage, health-care and defense spending, as well as layoffs of state employees and asset sales. It must implement that austerity with unemployment already topping 20 percent, meaning more retrenchment might end up only compounding the debt stress.

Dangers ‘Substantial’

“The danger of Greece saving itself into economic depression and having to default and exit the common currency zone remains substantial,” said Christian Schulz, an economist at Berenberg Bank in London. Jennifer McKeown of Capital Economics Ltd. repeated her forecast that Greece will quit the euro by the end of the year.

The odds that Greece will remain encumbered by debt were exposed by an analysis by European Union and International Monetary Fund experts that highlights what could go wrong with a country unable to grow out of its fiscal travails by devaluing its currency. In a worst-case scenario, the debt may rebound to 160 percent of GDP by 2020 rather than nearing the 120 percent the IMF deems “sustainable.”

“Given the risks, the Greek program may thus remain accident-prone, with questions about sustainability hanging over it,” said the report by the so-called troika, which also includes the European Central Bank.

‘Fully Fledged’ Default

The study exposes the difficulties Greece faces in delivering its promises amid a crisis-torn economy, said Guillaume Menuet, an economist at Citigroup in London. The country may miss its deficit goals as soon as June and have to prepare for a “fully fledged, coordinated default” by year- end, he said.

Joerg Kraemer, chief economist at Commerzbank in Frankfurt, calculates the debt ratio will rise to 127 percent if annual growth is 0.5 percentage points lower than assumed.

“Greece will find it difficult to shoulder even the reduced debt in the long run if it does not implement far- reaching reforms,” said Kraemer. “For the second half of the year, there is a significant probability that a frustrated EU stops payments to Greece.”

If 2010’s 110 billion-euro bailout is anything to go by, Greece will struggle to reach its targets. Privatizations supposed to reach 19 billion euros by 2015 have so far yielded about a tenth of that amount and Barclays Capital estimates that, even with promised fiscal cuts, just 16,000 state jobs were shed in the three years through the third quarter of 2011 compared with 466,000 in the private sector.

Outside Scrutiny

In a bid to prevent renewed failure even if it means eroding Greek sovereignty, European governments will tighten their scrutiny. A special account will be established that gives priority to keeping Greece solvent before releasing money for the country’s budget. A European Commission task force will also be embedded in Athens.

The biggest near-term risk may be elections which could be held as soon as April. In a poll released today, nearly every Greek questioned by GPO for Mega TV said the budget measures promised by the current government were too harsh.

“The new Greek government could refuse to follow through on its commitment,” said David Mackie, chief European economist at JPMorgan Chase & Co., who noted Europe’s leverage over Greece will recede once investors complete a debt exchange and the first aid payments are received.

Debt-Swap Relief

Other hurdles remain. Unless 90 percent of investors sign up to the bond swap, Greece may need to enforce it, creating legal difficulties. Finland and Germany are among the nations whose lawmakers must back the new loans as voters attack the bailouts. German Finance Minister Wolfgang Schaeuble said the IMF plans to add 13 billion euros to the bailout, less than the third it contributed to the first program.

The euro area has nevertheless “bought time” for countries such as Portugal to prove they are more creditworthy than Greece and to erect stronger defenses in the form of a larger bailout fund, said Carsten Brzeski, an economist at ING Groep in Brussels.

“The often-cited Greek can has again been kicked down the road,” he said. “The good thing is that the can is still on the road, but it requires a huge amount of stamina and patience to keep it there.”

Indeed, there remain significant risks with the Greek experiment, especially now that millions are trapped in unemployment and many more will be joining them. But financial oligarchs got their way and decided to put Greece on life-support, for now. It remains up to Greece to implement reforms and more importantly, come up with a way to attract foreign investments so that the country can start growing again. Austerity and growth do not mix well; this will be a Herculean task for Greek leaders.

Nevertheless, as I stated in my last comment on whether we'll get a melt-up or meltdown following this deal, I still see a liquidity-driven melt-up as the biggest tail risk right now. Investors need to shift their attention away from Greece and Europe and start focusing more on the U.S. recovery. Skepticism still abounds but that won't make you money in these markets.

Below, Mark Blyth, professor of international political economy at Brown University, talks the outlook for Greece's debt crisis. Blyth speaks with Erik Schatzker and Sara Eisen on Bloomberg Television's "InsideTrack." he basically echoes professor Yanis Varoufakis: "...this is a solvency problem that they're trying to solve with a liquidity instrument."

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