17 June 2011

Greece, eurozone and the euro: the body is really getting rotten

1. The EU wobbling around the Greek ongoing crisis 
Since early May, a succession of events and a flurry of declarations coming from all corners of Europe, often antagonistic, have again put the eurozone to the forefront of the news (Greece's fable continues to unravel). Greece is moving closer to political chaos and the impotency of European leaders is not discontinued.
The rift between the ECB and European politicians as well as politicians between themselves is widening: the ECB and the European Commission stand against a debt maturity lengthening whilst Schaeuble, the German Finance Minister supports it and Lagarde, the French Finance Minister and to be Director General of the IMF opposes it, since it would be considered as a credit event i.e. a default; rating agencies are adopting the same view. Then what is a credit event is also subject to interpretation and arm twisting (watch how much US banks would loose if they had to pay on CDS they wrote on Greece to European banks and insurance companies – no doubt rating agencies would be under a lot of pressure).
The latest trick to share the burden of the flawed eurozone construction and 2010 Greek rescue is to propose private creditors to “voluntarily” agree to purchase new Greek bonds when existing ones mature (no talk about the interest rate) for approximately EUR 30 billion over the next three years. Trichet however stressed that the ECB has no intention to rollover its own holding of Greek debt: true the ECB is not in the private sector! However, I am convinced that the ECB would buy new Greek debt from banks in the secondary market so, no change – an inflated ECB balance sheet and banks reducing their exposure to PIGS.
Rating agencies indicated that anything that would look like a forced conversion would trigger a default. Trichet is on the same line when he declared in Frankfurt on June 9: “We exclude all elements which are not voluntary.” There are already reports that French banks would be ready to rollover their Greek bonds: phone calls have gone at light speed between French Government officials and Heads of banks…
Fitch added that a Greek debt swap offering investors terms “worse” than those of the existing securities would constitute a coercive or distressed exchange, and be considered a default. Another criterion for assigning a default rating is that the exchange “is, or appears to be, necessary to avoid insolvency and/or illiquidity”. But for arm twisting, rating agencies would declare that Greece has defaulted on its debt obligations.
As Bloomberg reports: “Sustained ECB resistance could leave politicians facing the prospect of asking their taxpayers to finance a Greek budget shortfall that may amount to 90 billion euros ($130 billion) through 2014.”
I have no doubt that one party will bend, none wanting to contemplate the consequences of the absence of some form of agreement, how bad it is, and overall not bear the responsibility of a failure.
2. A new rescue package
After over a year of stubborn refusal, talks are now about letting the private sector share
the burden of Greece’s insolvency (only lying or utterly incompetent politicians could say it was a mere liquidity crisis).
Under pressure from his fellow European pairs, Papandreou agreed to EUR 78 billion additional austerity measures and asset sales until 2015 (EUR 6.4 billion spending cuts in 2011 and another EUR 22 billion in 2012-2015, plus EUR 50 billion privatizations), yet to be passed before the Greek parliament, in order to persuade the IMF to release its share of the EUR 12 billion tranche (EUR 3.3 billion) originally due later in June and now early July.
The size of a new bailout for Greece has increased week after week. Late May, we were around EUR 45 billion, then EUR 90 billion and now some talk about EUR 120 billion, including asset sales by the Greek Government (and if they achieve EUR 25 billion until 2015 - 50% of what is planned - it would be a real achievement). Aproximately 42% would be lent by eurozone countries and the IMF, 29% would come from both Greece’s asset sales and rollovers by creditors.
However, extending maturities by seven years, as suggested by Martin Schaeuble, is only kicking the can down the road, which European politicians have been very good at (right, teens do that too). It would give banks more time to get rid of their PIGS debt to the ECB, completing the full transfer of risk from the private sector to the ECB.
This would add to the already EUR 75 billion purchased by the ECB (EU 40 billion of Greek debt according to Barclays Capital) under its Securities Market Program which ends up financing Governments, event if the contrary is stated.
As outlined by Markets & Beyond over a year ago, the politically motivated EUR 110 billion rescue package had no chance to succeed not addressing the roots of the problem: over-indebtedness and lack of competitiveness. There was no way that Greece could return to the bond market in 2012 as planned in the rescue package (EUR 27 billion to be raised in 2012).
Without a dramatic increase in revenues (read GDP), the current potion instilled by the IMF and the EU is a death kiss.
3. Take a sit back and relax: the reality of hard facts
A second rescue plan will fail as did the first one. EU politicians are only interested in gaining time praying that growth and inflation will do the job for them.
The austerity program of Greece is plunging the country into a prolonged decay, unemployment having reached a record 16.2% in March, up from 15.9% in February and GDP at current prices down 0.5% in March QoQ (-5.1% YoY) which weight on public finances. Preliminary data in May show the Central Government budget deficit widened in the first five months of the year to EUR 10.3 billion (+14% compared to the same period in 2010 and +35% if one does take into account massaging of the Public Investment numbers for approximately EUR 2 billion).
For the period 2011-2015, on rather optimistic assumptions, Markets & Beyond calculations give EUR 105 billion of cumulated additional deficits plus EUR 108 billion of maturing long term debt (and short term financing could also come into question– Greece has not been able to finance itself at 52 weeks since May 2010, only 13 and 26 weeks). And this does not take into account the Financial Support Mechanism loans from Europe and the IMF...
According to banquet Pictet, Greece’s nominal GDP would need to grow by 21% annually for the next 10 years at 12% financing (we are around 18% right now) to get back to the Maastricht criteria of 60% Debt/GDP: we are living on Mars! If one was using 4% GDP growth and 4% cost of financing, with EUR50 billion asset sales and 2% primary budget surplus, it would take Greece 45 years to reach 60% Debt/GDP ratio!!
Tightening fiscal policies and increasing tax collection are necessary but will be far from enough to solve Greece’s debt trap; asset sales will reduce the financing gap but we are talking about stock, not cash flows. Top line must dramatically improve, i.e. GDP growth and exports. This will not be possible before a prolonged period of time without getting a kick in the arm.
My view (let’s dream):
  • Restructure debt with a 50-70% haircut to reduce debt to manageable levels
  • Run the fiscal policy independently from Greece, in effect putting the country under tutelage, to avoid getting back to square one 5-10 years down the road
  • Improve competitiveness to foster GDP growth (and exit the euro?)
This would have a spillover effect on other eurozone countries and US banks that wrote CDS to European one, therefore:
  • Debt to equity swap and/or straight nationalization for banks that could not sustain book losses or raise equity with the private sector (estimated by Markets & beyond anywhere between EUR 300-450 billion) – there are 6000+ credit institutions in Europe ensuring a wide mutualization of risk
A Greek default would represent 1-2% of European banks capital base, A PIGS default would add 10-12%, this would be serious business, still manageable if well planned ahead of events which the eurozone has failed to do so far
  • Recapitalize the ECB that would be (is) insolvent
  • European banks would reduce their losses by triggering CDS payments, further pooling the risk with US banks
Where eurozone politicians are leading us:
  • Short term
    • a voluntary (sic!) purchase of new debt by banks when old ones mature
    • Gain a bit of time (6 months to 1 year)
  • Longer term term
    • A default, which CMA currently rates at over 75% probability, with a 50-70% haircut minimum
    • A quasi permanent fiscal transfer from the eurozone (read Germany) to Greece (and then the rest of PIGS)
In any case, down the road, Greece will default.
So far European leaders have been impotent and preferred to muddle through instead of grasping the problem, blinded by the European construction (destruction in fact) dogma: adding debt to debt will not resolve over-indebtedness. The longer it takes, the more painful it will be.

Les Echos: Fitch Outlines Rating Approach to a Sovereign Debt Exchange
Bloomberg: numerous articles

Reuters: EURO GOVT-Peripheral debt under pressure, overshadows ECB

CMA: Market Data – Sovereign Risk Monitor
Pictet & Cie: Protection prudente des portefeuilles en temps de crise