28 October 2011

Euro summit: kicking the can down the road once more

1. The agreement
As for a well written movie script, the 4 am press conference concluded weeks of discussions, haggling and wrangling about this Greek drama. Like the other 10 or so summits about the eurozone crisis, this is meant to be the final shock and awe response to years of denial, the ground-breaking decisions.
The agreement can be summarized as follows:
  • Nominal write-down of 50% (EUR 100bn) of Greek debt in private hands; Greek debt owned by official lenders not touched (so the ECB will not need to be recapitalized)
  • Remaining Greek debt will be refinanced at preferential rates
  • Bond swap to be done by end-January 2012
  • Closer supervision of Greek adherence to the program
  • EFSF to be levered 4-5 times
  • No ECB involvement in EFSF 
  • President Sarkozy will speak with China on EFSF
  • EFSF will have both a direct insurance and SPV element; looking for EM/IMF support for the SPV
  • Estimates of EFSF firepower ranged from EUR1.0-1.4 tn
  • Italy to deliver specific budget 
  • Banks will raise EUR 106 billion of Core Tier 1 capital by the end of 2012 to reach a 9% capital ratio (plus an additional EUR40 bn capital buffer).
Thursday, market reaction was enthusiastic with bank stocks gaining double digit (Crédit Agricole up 23%!) and the EUR jumping 2% vs. the USD. This looks however more like a relief of not being dead than anything really of substance so far since there is a lack of detail and a lack of surprise. Today’s (Friday) Italian bonds yields are reaching 6% again and French bond spreads to Bund are widening close to 1%.
Finance Ministers will decide details in November: as always the devil is in the details.
2. Analysis

  • The 50% haircut the private sector will “voluntary” write-down represents EUR 100 bn (EUR350 bn - EUR70 bn Troika loans - EUR75 bn held by the ECB)*50%: this pushes the debt/GDP ratio down to 120%.
  • The press release indicates: “…with an objective of reaching 120% [the debt/GDP ratio] in 2020”. So, if I correctly read this section of the press release and based on September IMF numbers, it means that the Greek situation will not improve for the 10 coming years or so at double the Maastricht Treaty criteria and back to where the ratio was in 2009. In addition, I doubt that structural reforms, if really implemented, will produce results before years to come and a GDP decline is to be expected for the next 1-3 years in the absence of currency devaluation.
  • Finally, according to IMF projections, and nothing beyond the EUR 100 bn forgiveness has changed, the debt/GDP would reach 143% in 2012.
  • Investors could question the quality of the EFSF guarantees (which only apply in case of default) since the ISDA declared that the 50% haircut being “voluntarily” gun-to-my-head does not constitute a credit event therefore a default. The same thinking could apply in the future to the guarantees provided by the EFSF on bond purchased from Greece (or other Eurozone countries). In addition:
    • Since it is meant to be voluntary, some could choose not to exchange their current holdings for new bonds weakening this frail restructuring if numerous enough
    • No detail on how it would be structured: maturity of new bonds, interest rate, guarantees if any, ruling law, to name a few
    • Other EZ countries could give up and ask part of their debt to be forgiven
     Despite the EUR100 bn debt default, this is not going to have much impact on the Greek budget: for over a year, Greece has not borrowed on capital markets but with the Troika and short term T bills at c. 5% and not at secondary market rates of 20%+.
Saving: EUR106 bn*5% = EUR5 bn i.e. +/- 25 % of current interest payments or 2% of GDP.
This will leave the country with a negative primary budget running at about EUR1.5 bn/month or 30% of state’s revenues.
  • All this is gaining some time, but does not address the issue of the lack of state cash flows generated by the absence of growth, a weak central state and a large black as well as uncompetitive economy.
  • EUR106 bn of new core capital will not be enough if other Latin European sovereign debt is marked-to-markets (just think Italy).
All this edifice also assumes no AAA downgrade for France, which I do not believe: France does not deserve a AAA rating.
This week’s measures bring some short-term relief but are far from being the shock and awe required and is short in details: European leaders once again kicked the can down the road, farther this time, I admit.
The winner is China that will have a strong hand with Europe while protecting its largest market from collapse as well as its EUR 600 bn of European debt.
As a side comment, European leader were prompt (and rightly) to name and shame leverage as the culprit of the financial crisis and are doing the same with the EFSF.

European BankingAuthority: The EBA details the EU measures to restore confidence in the bankingsector