Sony Kapoor: A plan to rescue Greece and save the Euro

The FT carries has an op-ed with an interesting proposal for resolving the eurzone crisis.  (A shorter version of the article appeared following the Roubini piece that Kevin linked to yesterday.)

The essence of the proposal is a selective Greek default, with preferential treatment given to official creditors.   Whatever the merits of such selectivity, the proposal does offer a way for Ireland (and Portugal) to differentiate itself from Greece.   This is done through the use of explicit triggers before invoking restructuring under the ESM. 

[C]ontagion to Ireland and Portugal can be avoided through the introduction of an ESM clause that allows debt restructuring only when the debt/GDP ratio and debt servicing/GDP ratios exceed 110 per cent and 6 per cent respectively, levels that neither Ireland nor Portugal are expected to breach. The markets recognise that Greece is different.

The proposed debt/GDP ratio looks too low based on current projections.   It would probably need to be in the vicinity of 130 per cent to allow for adverse shocks.    But an explicit trigger set at reasonable level would give confidence to markets that a country following its programme would not be forced to impose a restructuring as a condition of any future programme.   (However, the preference given to official creditors would make a restructuring very costly for non-official creditors in the event that the trigger was breeched.)   The threat of restructuring is now making it almost impossible for Ireland to regain market access.   The proposal offers a way of both resolving the Greek crisis and avoiding rolling contagion through policy precedent.

94 thoughts on “Sony Kapoor: A plan to rescue Greece and save the Euro”

  1. The NTMA expects GGD to hit 110.8% of GDP in 2011 rising to 118.3% in 2013 ( http://www.ntma.ie/Publications/2011/GG_debt_NTMA_info_note.pdf ).

    The Stability Program Update from earlier this year expects the interest cost to exceed 6% of GDP in 2013.

    These are not secret nor unimaginable numbers. They are not difficult to find out. How lazy do you have to be not to find them? How stupid do you have to be to write about expected levels of debt and debt servicing costs without looking to see what the figures are?

    Next!

  2. @Hogan

    Granted he needed to do more homework. But surely we are smart enough to make the needed correction and take it from there. If that is the only basis for dismissal, it is hard to fathom.

  3. A couple of questions:

    “The timing of these haircuts is flexible: they could happen now or in July 2013, when the European Stabilisation Mechanism is activated.”

    Is the ESM mechanism retrospective or not? Is the idea that it will only retrospective in the case of Greece?

    “…in turn triggering contagion.”

    The triggering of contagion is twice put forward as a given if the Greek bank bonds are haircut, but not so much if sovereign bonds are. Is this an opinion, or is there some factual basis?

  4. @John McHale: The threat of restructuring is now making it almost impossible for Ireland to regain market access.

    Maybe. Personally I don’t think it makes sense to pick out a single factor as the main obstacle to market access. For example, think what would happen if some large international bank offered to take one of the twin pillars off our hands. In that unlikely event, Irish bond yields would drop like a stone. So maybe it’s the banking millstone that is making it impossible for Ireland to regain market access? So what we should be asking is, why are these businesses so unsaleable and what can we do about that?

    Of course I’m not really suggesting you swap your one-dimensional approach to the problem for mine. There are many ways to skin this cat and the politics will determine which way is eventually chosen.

  5. What is original in this proposal? Just a haircut + a bit of realism on Greek banks. Frankly, I could have proposed that myself.

    I think there is at this stage way too much attention to the debt level. The real problem is to bring the deficit down. That is what is hurting the economy. Haircutting the debt does not really change the situation in this respect. The debt can be dealt with later.

  6. @John McHale
    “The threat of restructuring is now making it almost impossible for Ireland to regain market access. The proposal offers a way of both resolving the Greek crisis and avoiding rolling contagion through policy precedent.”
    Well, does it really? The problem I have with the article is that it is addressing the effects and not the cause. Excessive deficits lead to excessive debts leads to lack of market access. The lesson, if there is one, from Iceland’s return to the bond markets must surely be that a deficit of 1.4% enables a return to the debt markets, that is, evidence of ability to pay is what gives market access, not a notional debt or repayment level.

    That is my real beef with the article – it doesn’t address the problem, it provides a solution to the wrong issue.

  7. The comment below tells me that no matter what the proposal normal capitalism rules are not likely to be enforced:

    “..Plan B must also differentiate between the various creditors. EU loans and European Central Bank support provided after Greece got into trouble must be treated preferentially. Private holders of Greek debt would have been worse off without this public support, so the EU and ECB debt should not be restructured. In 2013 this can simply be transferred to the ESM, which will have preferred creditor status…”

    With respect this is complete nonsense – think about risk and returns – given the fact that the risks associated with the Greek sovereign were markedly higher when the ECB and EU stepped in, it stands to reason that their investment would and should be the first to take a hit – at the time they knew the risks – previous bond investors were sold a pup – the previous Govt numbers were deliberately masqueraded as accurate whereas in fact they were anything but.

    In such a scenario, if there was ever a case for compensation then, the original bond investors would rightly be the first to be paid. They were lied to, the ECB knew the risks.

    ‘We saved you’ seems to be the argument set forward here ‘therefore without our support you would be a goner’ – this is nonsense – risk capital lent at rates which compensates for that incremental risk in the same category of bond should be treated exactly the same as previous incumbent bond holders. Who provided the support is irrelevant.

  8. At what point and under what circumstances would domestic politics demand a dip into restructuring territory in order to wirte off some debt?

  9. window dressing, lets get on with the real cuts asap, straw men will not fool the investor only radical surgery – one simple question for the glitterati on this site would you invest your nest egg in Irish government bonds following the implementation of such a plan as above?

    Even Irish banks seem to be preferable to government debt…

    http://www.taxation.ie/2011/05/flight-of-banks-capital/

  10. @ grumpy

    Exactly my thought. If the debt/gdp ratio got to 125%, and a haircut was triggered at 130% wouldn’t there be a temptation there?

    On balance, I don’t like the sound of an automatic trigger as it sounds like the Schlieffen plan.

  11. @grumpy

    I don’t have a good answer on the politics. I have argued before that Ireland is “between two stools” — not willing to restructure but with the significant threat of future restructuring hanging over our creditworthiness. We need to move one way or the other, either go ahead and restructure with official support or take the threat of restructuring off the table to the maximum extent possible. In my estimation, Greece needs to move the first way and Ireland the second. This article is interesting in that it suggests a way to achieve both.

  12. I made a small spreadsheet to model rapidly the level of Greek public debt in the coming years. Nothing fancy of course. I took the EU GDP growth forecasts as starting point, and assumed that the deficit comes down by 2% of GDP every year until 2016 when the budget is in balance. On top of that, I have assumed €50bn of privatisations spread between 2011 and 2016.

    The conclusion is quite suprising: debt to GDP would then be only 130% of GDP in 2016. Of course, the key issues are of course how GDP will really develop and whether Greece could really succeed to bring the budget in balance.

    Just food for thoughts …

  13. @Kevin and rich

    It is not an either\or situation. Of course we have to cut the deficit, and at a faster pace than now planned given the risks we face. But if you have been watching the timing of yield spikes and the pronouncements of rating agencies you will know how much the ESM design matters. I don’t think it is helpful to dismiss everything that does not fit your preconceptions as stupid.

  14. @ rick,

    presumably as the cuts have been such a resounding success in Britain we should ‘get on with it’.

    Serious people, and not the glitterati, have said it must be so.

    By the way highly enjoyable blogs by Krugman about the phenomenon of serious people and their increasingly insane policy prescriptions in America recommending cuts and promising nirvana

  15. @Yields or Bust

    “With respect this is complete nonsense – think about risk and returns – given the fact that the risks associated with the Greek sovereign were markedly higher when the ECB and EU stepped in, it stands to reason that their investment would and should be the first to take a hit – at the time they knew the risks – previous bond investors were sold a pup – the previous Govt numbers were deliberately masqueraded as accurate whereas in fact they were anything but.

    In such a scenario, if there was ever a case for compensation then, the original bond investors would rightly be the first to be paid. They were lied to, the ECB knew the risks.”

    I think you are missing the point. You could make such argument if the EU/IMF loans had been return-seeking risk investments. They were not. Instead, they were crisis financing intended to keep the country going when no one else was willing to lend it. By well-established tradition, such lending is senior to other liabilities.

    Two cases in point: for precisely this reason, the IMF has an internationally recognized preferred credit status. A similar hierarchy exists in many countries’ bankruptcy code. In the US, it is known as debtor-in-posession financing, and is senior to all other liabilities.

    That said, it would in any case be difficult to treat the EU loans as super senior, since they were granted with the explicit announcement that they would be pari passu with other sovereign obligations. This announcement was made to create incentives for private investors to maintain their exposure to Greece.

    Further, ECB lending has a bit different status, as it was made to banks, not the sovereign, and is collateralized.

  16. @John McHale

    If these proposals are ever implemented, a third one should be added.

    Namely, the amount by which a country reduces the value of its debts to foreign countries by devaluing its currency against the currencies of those countries which lent it money.

    Devaluing one’s currency is simply a way of defaulting, that relies for its success on those, who are being defaulted on, also being too dumb to know that they are being defaulted on. Even if people in Ireland fall into that category, the clever Chinese aren’t. A Chinese ratings agency says exactly this:

    http://georgewashington2.blogspot.com/2011/06/chinese-rating-agency-says-us-has.html

    Their reference is mainly to the US. But, it is even more true in relation to the UK, which has devalued its currency by 23 per cent against the euro since June 2007. Can any economist explain why the Chinese view is wrong, and the view of US/UK-based ratings agencies correct? Naturally, the latter will never include this in their definition of default, precisely because they are US/UK-based and the governments in both those countries have clearly made a decision to welsh on their debts by the simple expedient of devaluing their currencies against the currencies of the countries which lent them money, and will then pay the debts back in their own currency, by which time they will be worth a lot less. As Shakespere wrote: “A default by any other name…”.

    If anyone disputes this analysis, let me offer them a deal. Lend me one million £sterling today. I promise to repay it in £sterling in 2016, having generously augmented it for them by average UK deposit interest rates between now and then. Any takers?

  17. I wonder if “the people” haven’t already decided to cast Greece adrift and expel it from the EZ. Dan O’Brien’s recent article was very critical and brought in a load of irrelevant points (eg the expelled Greeks of Asia Minor in 1923) so what was he aiming for ?

  18. @Anonymous

    Sorry don’t agree – the situation in Greece is different in that the original bond holders were duped – it is not an Irish case. The new Govt in Greece realised very quickly on taking office that the numbers were deliberately falsified for years – any subsequent investors were investing in the knowledge that all the information was on the table. This matters or at the very least it should.

    And by the way the rate charged by the ECB was borrowed at the market plus a lending margin to Greece so they are in fact ‘..return seeking risk investments’ – which are higly likely to go sour.

    There are many invetsors still willing to lend to Ireland, Greece and Portugal – its not the lack of cash its the rate they charge is the issue for the Govts in question. Ireland doesn’t necessarily require the IMF at our door if we were willing to pay the going market rate we would still have our sovereignty – the downside of course would be the more dramtic austerity required to reduce the marginal borrowing rate – so the point that no one else was willing to lend to Greece is not accurate – the lenders are there (were there in the case of Greece) its the rate at which they are willing to do business is the issue.

  19. I think this is a sensible proposal and would help calm the markets.

    Not sure why ECB holdings should be excluded from restructuring. Surely as holders of bog standard Greek bonds they should not be given special treatment, or is this one of the reasons why the ECB is so against a restructuring now?

    The problem will then move to what are sensible trigger points for a sovereign default
    The levels quoted do seem a little on the low side, what do you think are sensible numbers John McHale?

  20. @Gavin

    Must admit I had to look up the Schlieffen plan.

    You raise a valid point about automatic triggers. However, I do think the incentive issue you raise can be dealt with. At the moment, the government is trying to avoid default, so the incentive is to not push over the threshold. But you are right to imagine this changing. The counter is that a country’s qualification for a new programme would not be automatic, so that if a country was seen as not making sufficient fiscal effort, or indeed trying to game the system, it would not receive a new loan. The point of the trigger is that if a new loan is required and granted it would come with restructuring of existing debts. This does weaken the reliability of the lender of last resort function, but I think it is unavoidable.

    What I am groping towards is a way to prise open the window back to the markets. The combination of doubts about fundamentals and a badly designed permanent rescue mechanism are interacting to slam that window shut. I too have doubts about the Kapoor proposal. But what is important is that, in as an open-minded way as possible, we are exploring ideas about how to fix this mess.

  21. It is obvious that the ECB is opposing restructuring because that is the best way to keep the Greek banking sector solvent and continue to fund it to the tune of €80bn with Greek bonds as collateral. If Greece defaults, the ECB can not continue funding Greek banks, either because they become insolvent or because they run out of acceptable collateral.

    Then either Greece has a banking crisis on its hands. That would make the necessary budget adjusments even more difficult impossible and would force Greece to leave the Euro. One should wonder whether that is the objective of Germany.

    Or the EU steps in to save the Greek banking sector: €80bn of funding + €xxbn of recapilasition?

    My conclusion: unless you want to push Greece out of the Euro, I do not see how a default would really reduce the amounts that taxpayers from other EA countries have to provide.

    And a default of Greece would probably create a lot of additional problems in the Euro Area.

  22. @ All

    According to German press reports, euro area ministers are meeting informally this evening (and the 27 subsequently?).

    From the signals emanating from various sources, the “compromise” will be a Vienna Initiative type solution (which even the most inventive credit rating agency would find difficult to question) with the ECB not participating i.e. beginning the reversal out of its bond buying programme.

    Any agreement reached will set the template for the wording of the ESM. It seems that private sector involvement will be very much optional.

  23. In summary:

    Protected:
    -EU loans and European Central Bank
    -Greek banks

    Unprotected:
    -private external holders of Greek debt, Hint: German and French banks

    It seems to me there must be many more classes of debt holders. Pensions, governments, religious institutions, individuals, … So the article is just a start.

    An off topic note: In the US there is some concern as to those bond default insurance schemes and how much US banks will be forced to pay.

  24. @John MCHale: I don’t think it is helpful to dismiss everything that does not fit your preconceptions as stupid.

    I don’t believe that I do, nor that you know very much about my preconceptions.

  25. @Yields or Bust

    “And by the way the rate charged by the ECB was borrowed at the market plus a lending margin to Greece so they are in fact ‘..return seeking risk investments’ – which are higly likely to go sour.”

    You probably meant to say “EU” instead of “ECB”. The ECB did not need to borrow from the market. As a central bank, it just created the money.

    As to the EU lending – did, in your opinion, the EU countries push through the politically very difficult parliamentary decisions and agree to the 110 bill. euro financing to Greece because they

    a) saw it as an profitable investment opportunity, or
    b) because they saw Greece in trouble and considered it their duty (both to Greece and to broader financial stability interests) to help the country get back on its feet?

    If you choose a), then your interpretation of history is quite unique.

    “There are many invetsors still willing to lend to Ireland, Greece and Portugal…”

    I’m sorry, but you are deluding yourself. Yes, there exist a secondary market for Greek, Portuguese, Irish debt, and, although volumes there are almost zero, there are some buyers there, and there is a price there. But that does not mean that Ireland would be able to finance its deficit at the current secondary market prices.

    Certainly for Greece, and most probably for Ireland and Portugal, the only reason there are any buyers is the possibility that, with the availability of relatively affordable official financing, the countries have a change of regaining debt sustainability. If Greece, instead of borrowing from IMF/EU, were to try finance itself at the present 20+% interest rate, increased debt servicing cost would change the whole debt arithmetics so drastically that any change of returning sustainability would vanish and so would the buyers.

    Ireland is in a better shape than Greece, but not that much better.

  26. @Anonymous

    Correct it was the EU not the ECB.

    Just so your aware Greece raised €1.6bn today at the rate of 4.96% (26 week duration). There is no delusion here its a fact – check it out.

    I understand that the rate at which Ireland etc would have to pay for cash would be extremely difficult for all concerned but it would simply mean the march to fiscal correctness would have to hasten up markedly from here aka Michael Hennigans approach – it will happen anyway.

    The point I’m making is that no matter where you stand as a lender your a risk taker be it for the purposes of country salvation or otherwise. In relation to your options obviously I accept that b is the answer – but that’s not the point the point being is that the EU is still putting cash at risk and that should not preclude them from suffering losses in line with previous Greek bond investors who were lied to in the event of a credit event. Is the EU euro of any greater quality than the private investor other than it was provided at a different point in time for which they earned a rate of return. In my opinion the answer is no.

  27. @ John.

    Thanks.

    On the implications of the Greek crisis for the US (something I hadn’t really thought about) Matthew Yglesias has an interesting post. Yglesias is a fine example of a non-economist who has worthwhile comments to make on economics. I’m a bit alarmed to learn that 44.3 percent of prime money market funds in the United States are invested in the short-term debt of European banks. It doesn’t make me like Tim Geithner any better, but I do see that he has a problem.

  28. @ Kevin Donoghue

    I’m not an economist but it appears likely there is a very significant problem for the US (and subsequently in a Lehmanns scenario everyone) if an EU country defaults. Geithner was on the phone (according to Morgan Kelly) in November about Ireland and about Greece in March because Wall St banks have taken the wrong end of credit default swaps on EU state debt. John Mauldins website suggests it exceeds a 100 Billion liability on all of the PIGS and that the famous exposure of the French and German banks is actually quite well insured (surreal though it is quite possibly ultimately with AIG who were doing CDS’s long before they had to be bailed out for doing CDO’s).
    Contagion on a Greek default is not limited to the markets coming after the next PIG it is also the “credit event” that triggers the swaps and then its 2008 again and no-one know which US or EU bank or insurance company has just gone bust because no-one knows who the counterparties are. What is reasonably certain is who ever loses big in the US either its another Lehmanns or their taxpayer has to foot the bill which is presumably why Geithner is putting pressure on to prevent defaults.

  29. If these thresholds are adopted it would make sense for Ireland to run the biggest deficit possible, paying any interest rate it takes, so that deficit and debt levels rise to the point where it can default and start recovery. Of course, a more direct route might be…….

  30. What I do not understand is why EU countries are not considering Brady bonds for Greece. Given that many Greek bonds are trading at very large discounts to face value, it would be easy to propose Brady bonds at a substantial premium to current levels, while also achieving a substantial reduction in the face value of Greek debt.

    Take the 10 year bonds for example. They are trading at 50-60% of face value. I bet that if you would offer Brady bonds at 70-80% of face value, you would have a good take-up from private bondholders. Such a swap would be entirely voluntary, and would not trigger a default.

    In fact, I would almost say that the cacaphony of the last few weeks was a perfect preparation for such a move.

  31. Another problem with the suggestion is that it is time-limited.

    It says that at time x, a sovereign can sustain 110% debt:GDP and repayments of 6% and so an arbitrary decision is made that there cannot be restructuring below those limits and will certainly be above them.

    Supposing, though, that there is another credit crunch at a time of rollover? What then? Interest rates spike as does risk aversion. Anyone within an asses roar of either limit is going to be punished by prohibitive rates or no buyers. In this case, they will go bust anyway.

    Even if there isn’t another credit crunch, what is to say that interest rates will stay on average below 4.6%? That is an astonishingly low rate.

    It is an attempt to draw another artificial line in the sand without, as you say @JohnMcH, sitting on either stool.

  32. @George

    Protected:
    -EU loans and European Central Bank
    -Greek banks

    That is the way I read it. Then some changes in the law to shift the burden to large EU banks!.

    Another interesting comment at the beginning of the article.

    Simply restructuring debt owed to the private sector will bankrupt the Greek banking system, and trigger contagion.

    In other words, don’t touch depositors, at least not yet! I do not wish to keepin banging on about this but how can Europe run a deposit based banking system when every dog and devil that loans money to banks comes before depositors?
    The answer?

  33. @Hogan and others

    I do see the problem with a rigid trigger. I would be interested in suggestions that allow for the option of restructuring for countries with clearly unsustainable debt, but which strenthens that perception of. LOLR sans restructuring for countries meeting ex ante condtionality and a reasonable liklihood of being able to achieve debt sustainability — ie how do we open the window back to the markets?

  34. @Yields or Bust

    “Just so your aware Greece raised €1.6bn today at the rate of 4.96% (26 week duration).”

    I know. Make a wild guess who the buyers might be?

    Let me just say that this is not money that would be available in the absence of official financing.

  35. The overall emphasis on austerity as a solution for the EU reminds me of the old saying, “The operation was a success but the patient died”. If you save the “economy” but the social fabric of society is destroyed I think you might call it a loss. Events tomorrow in the Greek Parliament and on the streets of Athens will go a long way in determining the future of Europe. Stay tuned.

  36. @Anonymous

    Well I know one fund manager whose buying and as far as I know she doesn’t work for the ECB !

    You’re avoiding the issue re risk sharing – why should the EU/ECB be treated any differently to a private investor who was lied to by the Greek Govt in a credit event?

  37. @Yield or Bust

    I hope she is not using what remains of my miserable pension fund to do the buying.

  38. @Joseph

    The most successful investors are the ones who look where the crowd is going and quickly march the other way – she may very well be right – perhaps the EU/ECB simply won’t allow a default to occur and the austerity measures and related schemes (call them as you like) eventually do the trick – long shot I know but surely that’s in the price?

  39. @John McHale
    “ow do we open the window back to the markets?”
    – Cut the deficit – a fiscal plan that doesn’t rely on a confidence fairy – tax raises and spending cuts. A luxury VAT rate might help. Make it clear that the deficit will be closed.
    – Remove serious overpayments to public appointees. Make it clear that government will live within its means from the top down and from side-to-side (include those elements that are not formally considered ‘government’).
    – Put the guilty on trial (i.e. clean up the past, so investors can have confidence in the future). Make it clear a line is drawn.
    – Get medium term certainty on ECB funding. Make it clear that this is required to return to the markets.
    – Some radical stuff – universal health, universal pension, universal education.

    Enough pussy-footing around. Set the agenda for reform and deliver on it ASAP. Tell the market that these are the measures that will give it confidence, though I think that only the fiscal deficit (i.e. ability to pay) really matters.

  40. @Yields or Bust
    “The most successful investors are the ones who look where the crowd is going and quickly march the other way”
    😯
    Do you really think that?

  41. @DOCM
    Thanks, but I do not agree. You do not need Eurobonds to implement Brady bonds. You only need a stronger credit to enhance a weaker credit. You do not even need new bonds. Out of each class of Greek bonds, you could create two classes: one with an EU guarantee, that you get after accepting a haircut, and one without guarantee.

  42. @Incognito
    You’d have to be prepared to burn the unguaranteed. As we see from the Irish banks, that is not permitted, though, perhaps it would be with sovereigns which are, after all, subordinate to bank seniors?

  43. @Hogan

    I must be careful what I ask for, but certainly food for thought. 🙂

    By the way, such deficit cutting as a route to growth is what Krugman associates with invoking the confidence fairy. But I understand that you have market confidence in mind.

  44. @hoganmahew

    Well I remember reading Anthony Bolton near the end of February 2009 where he suggested that the time to invest was when the clouds were very dark but the chances of grey pepping through were sufficiently high in ones own mind to pull the trigger.

    With the S&P placing Greece on the lowest rung of the ladder and the ECB steadfast against a default of any description I can admit to understanding the preverse logic in believing that today of all days maybe the day to pull the trigger. I repeat it is a long shot but history tells us that being greedy when others are extremely nervous is generally a winning investment strategy.

    Glad to report its not my cash she’s investing though !

  45. @John McHale
    “By the way, such deficit cutting as a route to growth is what Krugman associates with invoking the confidence fairy. But I understand that you have market confidence in mind.”
    Ah, sorry, it is the confidence in growth fairy I have in mind – that confidence breeds growth. Mr. Krugman has his own confidence fairy – that spending breeds confidence. There appear to be a lot of fairies about in economic circles…

    My point is that we should not bake in a level of growth as a prerequisite for what we plan. We should plan based on current conditions and accept growth as a happy occurence if it does happen. If it does, we can restore capital spending, reduce borrowing requirements or repay some debt (depending on what appears most advantageous at the time). If it does not, we have not lurched from one crisis to another.

    So basically, we should aim to undershoot.

  46. @John McHale

    There is certainly a fear of contagion currently from the Greek situation. Therefore, the first thing is for the government to shout everywhere that they want to avoid a default at all cost, and that their preference is simply to pay back the sovereign debt.

    Second, there is still the little matter of the banks. If I am correct, the Irish sovereign was still weighted down by €200bn of guarantees on bank liabilities at the end of 2010. I do not remember when the guarantee runs out, but here is the path to follow IMHO:
    – Recapitalize the banks according to latest stress tests.
    – Conduct another round of stress test in one year time.
    – If results of stress tests are confirmed, cancel all guarantees.

    And then of course, there is the matter of the budget deficit. In my opinion, the deficit targets of the troika should be seen as absolute ceilings. Nobody will criticize Ireland if it is ahead of targets, and it provides a bit of manoeuvring room.

    Last but not least, increase the corporate tax rate. I do not understand why the Irish are so fond of putting the whole adjustment effort of the domestic economy. I regard increasing the corporate tax rate as a triple win: more tax receipts, less short-term impact on domestic economy, lower interest rate.

  47. Mr Incognito

    You are a hopeless europhile optimist
    1. Shouting is not a policy. The previous govt turned so many corners it met itself coming back
    2. Taking the most toxic stuff off the banks and recapping them to the highest core tier 1 in the world has not worked. This is because it has undermined the sovereign credit rating. Since bank funding rastes are a function of the sovereign (even though they be senior now), they are available at uneconomic terms so banks are forced to deleverage
    3. The only bright spot in the economy is the export sector and FDI is allegedly flooding in in response to lower wages, lower rents and low taxes.
    Perhaps we should reduce our CT to the effective French rate.

    How is Carla BTW?

  48. I would guess its largely Greek banks buying their bills, rolling over maturing exposures.

    My understanding is that T-Bills would be exempt from any mooted restructuring, hence the disconnect between Greek bills and bonds.

  49. “So maybe it’s the banking millstone that is making it impossible for Ireland to regain market access? So what we should be asking is, why are these businesses so unsaleable and what can we do about that?”

    They are unsaleable because right now the twin pillars are defaulting on their bonds and have triggered insurance payouts to counter parties. Their guarantors solvency is in question primarily because it is on the hook for not only their bonds but all the funny money from the lolr. Therefore, market access is denied for the foreseeable.

  50. @ tull mcadoo

    1. Well, shouting does not cost much for sure. And one should not underestimate the importance of communication in politics.

    2. “Taking the most toxic stuff off the banks and recapping them to the highest core tier 1 in the world has not worked.” There is no reason for it to have worked because it has not yet been done. The recapitalisation has still to come.

    “This is because it has undermined the sovereign credit rating.”
    The link between the solvency of the sovereign and that of the banking sector is the guarantee. That is why there is a good chance that (the perception of) the solvency of the sovereign will improve once the guarantee can be lifted. And to lift the guarantee without triggering a bank run, there must be confidence in the solvency of the banks. One aspect of that is the recapitalisation. The other is that there must be confidence that the potential losses have been correctly assessed. That is why the next stress tests are important.

    3. Of course, if you put all the pressure of the adjusment on the domestic sector, why should anyone be surprised that the only bright spot is the export sector?

    PS: BTW, I am not French, but Belgian, and I live in Germany. Anyway, the claim that the real CT rate in France would be 8% is complete bogus. This figure is calculated on the basis of a tax base which has nothing, but then really nothing, to do with the usual corporate tax base.

  51. @Incognito
    re:

    The link between the solvency of the sovereign and that of the banking sector is the guarantee. That is why there is a good chance that (the perception of) the solvency of the sovereign will improve once the guarantee can be lifted. And to lift the guarantee without triggering a bank run, there must be confidence in the solvency of the banks. One aspect of that is the recapitalisation. The other is that there must be confidence that the potential losses have been correctly assessed. That is why the next stress tests are important.

    So the banks come first, eh?
    The next stress tests? You cannot be serious?
    And if the next stress test are negative, do you propose to stress the sovereign a little further to unstress the banks again?

    Your thinking is the undiluted ECB view of how economies should be subservient to the banking sector. That view may win in the short term, even in the medium term but it is a view that will crash land as heavily as the many economies it has destroyed so far.

  52. I see Mickey Noonan believes there is a solution to the Greek problem..

    “”A satisfactory resolution will be brought about, which will not be a credit event,” Mr Noonan said in an interview with CNBC television in New York today. Mr Noonan is on a four-day trip to the US to promote investment in Ireland.”

    Perhaps we could have a little competition as to how to bring about a satisfactory resolution without triggering a “credit event” as defined by S&P.

    I am sure that some of the astute commentators here can come up with something. Personally I don’t have a bulls notion how it can be done given the criteria.

  53. Ceteris

    That would be easy. Just say it is not a credit event and let the rating agencies go hang. If you mark the Greek debt down to sustainable levels sure it will get downgraded to EEE of F or whatever but what will happen if the debt is reset at sustainable levels along with a primary surplus. There will be an unseemly scramble for Greek paper. The RAs are more laggards than leaders. They will be upgrading Greece about a year after default.

    Incognito,
    I not sure if we have much to learn from Belgain concepts of governance and banking regulation. Sadly, your country has no govt, a debt somewhere between us and Greece, rigidities more akin to Greece than Ireland and a banking system that is as insolvent as ours if the truth would be told. After all Fortis has had to be sold to the French for a song and KBC is still up a river in Egypt.

  54. @ Ceteris paribus

    If the institutions concerned “volunteer” to participate in a rollover i.e. replace maturing sovereign bonds with the purchase of new ones, with in all likelihood longer maturities, who will be claiming that a credit event has occurred?

    The “volunteers” – mainly Germand and French – have quite evidently already been lined up.

  55. DOCM,

    Are you changing your tune? I thought you were in the “no restructuring” camp. You are correct though, most of the camp followers of the ECB, including the banks have deserted and made prep for the inevitable. There seems to be a few die hards left in the bunker in Frankfurt a long with a few mercenaries (US Banks). A revolver and a bottle of cognac is being sent in as we speak.

  56. @DOCM
    I think S&P require “full repayment in a timely manner”. Would the requirement to “volunteer” be classed as coercion?. JCT has said he won’t participate. If you only have the French and German banks taking up the new stuff then they won’t get the relief they evidently need.

  57. @Yields or Bust

    “Well I know one fund manager whose buying [Greek T-bills] and as far as I know she doesn’t work for the ECB !”

    So Irish funds still have money to invest in Greek short paper…

    The Greek debt office reports that two thirds of the buyers were domestic, meaning Greek banks. The only source of liquidity for Greek banks is the ECB. This paper is going directly to the ECB as collateral.

    “You’re avoiding the issue re risk sharing – why should the EU/ECB be treated any differently to a private investor…”

    I explained the facts and reasoning in my first post.

    In short, the IMF will in any case be preferred creditor by established international case law. The EU will not, by virtue it denouncing that right in the outset.

    The ECB is a different, more complex case. It would take a haircut for the bonds in its Securities Markets Program, no question about that.

    But the majority of ECB lending to Greece is monetary liquidity to Greek banks, not sovereign, and against (market-valued) collateral. If Greek banks failed (almost certain in case of sovereign default) it would seize the collateral. It would probably take some loss, but not a big one.

  58. @ tullmacadoo

    Not at all! I always follow the sheet music. This is contained in the draft treaty text of the ESM to which I provide the link again.

    http://www.openeurope.org.uk/docs/draftesmtreaty.pdf

    The orchestra was tuning up this evening on the Greek partition but just could not get the tune right. No written declaration emerged. Maybe some of the volunteers have failed to turn up.

    More seriously, the draft text follows closely the arrangements for the EFSF and only a few articles seem still to be in dispute, notably Article 12.2 and 12.3 i.e. in the body – binding – of the text or in the recitals. The enthusiasm for some of the elements in the Term Sheet agreed in March may have waned. One cannot, for example, see much enthusiasm in France for insertings CACs in ALL new bond issues.

  59. @ Ceteris paribus

    The game has little to do with reality at this stage and everything to do with politics. The issue is the “share” the private sector will take in kicking the can down the road for another year or two until the players are in a better position to do something more permanent. A figure of 30 billion euro has been widely mentioned.

    JCT has indicated, and, more importantly, the new head of the Bundesbank, that the ECB would have no objection. What else is going on in the snakepit of German coalition politics, I do not know!

  60. @Incognito

    What I do not understand is why EU countries are not considering Brady bonds for Greece.

    I’ve often thought the same thing. but I think the answer is pretty simple – the ECB don’t want it. It all comes down to who pays – with Brady bonds the creditors paid, with haircuts in the 40-50% range. There were no government guarantees or taxpayer subsidies. Debtor countries collateralized their new long-term loans by buying 30yr zero-coupon US Treasury bonds, but these were not guaranteed by the US government. As you point out there is no need for a Eurobond. There were also growth related recovery mechanisms – e.g. in the case of Mexico they had to pay extra coupons when oil revenues exceeded a certain level. Once this occurred it acted as an incentive for the Mexico to redeem the Brady bonds, which it did, 20 years before they matured.

    I believe that when Honohan said on VB’s program the other night that BL had been hoping for more risk-sharing, that this was exactly what he had in mind. It wasn’t simply about haircuts for existing senior debt, but about putting in place a scheme whereby everybody could gain if and when strong growth in Ireland returned e.g. some form of GDP-indexed value recovery mechanism, along with a long term debt repayment program such that the annual debt servicing costs didn’t act as a brake on growth.

    None of this even got off the ground due to the ECB’s insistence on promoting its weird form of central-European risk-free capitalism. 20 years on, in a different continent, and in a different global environment, I’m sure the details of a new “Brady” bond program would be a little different, but given political will and enlightened leadership I am sure all those details could be worked out. There is no such intelligent or enlightened leadership in Europe today.

    Given that, at least some cracks are starting to appear in the ECB’s defence walls around the creditors. Seems the Austrians have joined the Germans, Finns and Dutch in endorsing private sector involvement.

    From a report today

    Echoing this hardline stance, Austrian Finance Minister Maria Fekter said “we can’t leave the profits in the hands of the banks and the losses in the hands of taxpayers.” But striking to the heart of the matter, she said she was “having a hard time imagining” that banks would join the rescue on a purely voluntary basis.

    The restructuring won’t be voluntary, except in name.

    Also the amount of private sector involvement may be bigger that expected:

    Asked during a parliamentary debate whether the private sector should contribute between 20 and 30 percent of the second bailout, Dutch Finance Minister Jan Kees de Jager said “it will be more,” according to a spokesman.

  61. @Anonymous
    “But the majority of ECB lending to Greece is monetary liquidity to Greek banks, not sovereign, and against (market-valued) collateral. If Greek banks failed (almost certain in case of sovereign default) it would seize the collateral. It would probably take some loss, but not a big one.”
    Yes, yes and depends.

    No-one knows for sure what the collateral is, but given the ECB has waived the rules on ratings for Greek sovereign debt…

    PS to everyone, it is the ISDA that will declare a credit event, not the ratings agencies, no? Any coercion into a voluntary settlement will be considered a default, if the case of AIB is anything to go by.

  62. @Anonymous
    Actually, the first ‘yes’ should be a ‘no’. From DOCM’s NYT link:
    “The Dutch finance minister, Jan Kees de Jager, told his Parliament in The Hague on Tuesday that the E.C.B.’s total exposure to Greece might be €130 billion to €140 billion, or as much as $200 billion. In addition, the E.C.B. has provided €90 billion of liquidity to Greek banks”

  63. @Bryan G
    “I believe that when Honohan said on VB’s program the other night that BL had been hoping for more risk-sharing”
    Indeed, and that coupled with his hope for longer talks and a more sophisticated plan. It appears that a rushed solution was entered into in the hope that it would be a dramatic line in the sand. I don’t think the ink was even dry on the MoU before some domestic and international commentators were suggesting that an additional debt load was not going to fix a problem of excessive debt.

  64. @ tullmcadoo
    “I not sure if we have much to learn from Belgain concepts of governance and banking regulation. Sadly, your country has no govt, a debt somewhere between us and Greece, rigidities more akin to Greece than Ireland and a banking system that is as insolvent as ours if the truth would be told. After all Fortis has had to be sold to the French for a song and KBC is still up a river in Egypt.”

    Well, I would not regard Belgium as the global governance benchmark. But right now the country is doing well, thank you: Q1 2011 GDP growth 3%, Q4 2010 employment growth 1.2% among the best, unemployment heading for 7%, deficit close to 3%.

    Regarding public debt, please bear in mind that we are coming from around 140% of GDP in 1993. And nobody had to bail us out to get back to the current level of 97% (84% in 2007).

    And yes, we had to deal with a number of serious banking problems, like so many other countries. Interestingly, at some stage of the Fortis saga, the Belgian government could have made a choice similar to Ireland’s. With hindsight, selling to BNP might not have been the best deal. But I have absolutely no regret about that. Unlike their Irish counterpart, the Belgian government made a proper risk assessment at the time and concluded that the risk was too high. They were right.

  65. @hoganmahew

    PS to everyone, it is the ISDA that will declare a credit event, not the ratings agencies, no?

    That’s my understanding too. From a report on CDSs:

    To determine whether a credit event has occurred, and whether an auction has to be conducted, ISDA holds an open conference call with market participants to vote and reach consensus on the contracts to be terminated and on whether the amount of affected transactions is large enough to warrant an auction.

  66. @Hogan

    PS to everyone, it is the ISDA that will declare a credit event, not the ratings agencies, no? Any coercion into a voluntary settlement will be considered a default, if the case of AIB is anything to go by.

    An extra judicial elitist quango (ISDA) will adjudicate on the disposition of loss. A kind of supreme self elected loss adjusters body.
    It just goes to show how the world governments have been emasculated by the banking elites.

  67. @Joseph Ryan
    Well, no, not really. Loss adjusters is exactly what it is. They determine that a loss has occurred and then they hold an auction of the bonds to determine what the loss actually is.

    What *is* emasculating is the fact that cash that has been set aside in margin calls on derivative contracts is senior to all other of a bank’s creditors. The margin cash gets paid out first in a liquidation. For those of us suspicious of Irish bank derivative books, the non-liquidation of the banks makes sense as it would mean that the “deposits from other banks” part of the loan books reflects a large amount of pre-committed cash, not a creditor that can be haircut.

  68. @hoganmahew
    My understanding is that the ISDA decides on credit events for CDS.

    But for many investors, what matters are the ratings.

  69. @ Bryan/Joseph/Hogan

    ISDA declares credit events (which may or may not be an outright default) for CDS or other contracts with a default clause (the ISDA Master Agreement for Derivatives or CSA’s etc).

    However, the ratings agencies also have a “Default” rating, ‘D’, which they will declare on any bond/security which has gone full on into default in their opinion, as well.

  70. @Eoin

    So if the ISDA and the CDS market participants do their own thing separately from any rating agency activity, why would it matter if the Greek sovereign bond rating is the worst in the world at CCC or one step lower at D? I can see why the defaulted debt holders would care about their losses but again this seems separate from any rating agencies view of the matter.

    There seems to be a major concern to avoid the optics of a ‘credit event’ – but if it doesn’t impact the bond holders or CDS holders, who does it impact?

  71. @BEB, seafoid
    Yes, the ratings agencies will have a D rating, but only, one presumes, after an actual default. Do they independently caluculate whether a restructuring is a default? Or do they just follow the ISDA, who seem to be a little quicker off the mark?

    Actually, this http://www.irishtimes.com/newspaper/finance/2011/0421/1224295159786.html suggests they will decide themselves, but maybe only after the closing date whereas ISDA has already commented on AIB?

  72. for those still up, interesting piece on FT website from tomorrow’s paper on options being considered — at least one would be a credit event and there are warnings it would require EU ( as opposed to ECB) liquidity support for Greece’s banks. Other options less drastic. ECB still holding out but clearly German, Dutch and other government under pressure……clearly implications here for us.

  73. @Hogan

    The margin cash gets paid out first in a liquidation.

    The more I learn about this s**t, the worse it gets.

    So the gambler that put up a 20% stake in case he loses, gets his money back first.
    Meantime granny, who had put her lives savings into a deposit account, goes to the back of the queue. Loses maybe. And there goes the burial fund.
    As Mrs T might say “it a funny old world”.

  74. “credit event” has a particular meaning in the context of cds contracts. The ratings agencies tend to make their own decisions. If bondholders are “encouraged” to take a rollover that is below market terms it is likely they will call it a default. They are both looking at similar but not equal things.

    For the sov bond market there is a political determination to get one over on holders of cds.

  75. @Hogan

    “No-one knows for sure what the collateral is, but given the ECB has waived the rules on ratings for Greek sovereign debt…”

    The ECB has indeed waived is its rating threshold, but the only thing this means is that Greek bonds remain eligible as collateral.

    In contrast, the ECB has not waived its valuation or haircut rules. So while Greek banks can still post Greek sovereign bills and bonds as collateral, these are valued at market prices and after that an additional haircut is applied. So for 100€ repo financing, a bank would have to post upwards of 220€ nominal worth of Greek 10-yr bonds as collateral. In case of default, the ECB would only make a loss for such repo if the recovery rate for the bond was below 45%.

    “The Dutch finance minister, Jan Kees de Jager, told his Parliament in The Hague on Tuesday that the E.C.B.’s total exposure to Greece might be €130 billion to €140 billion, or as much as $200 billion. In addition, the E.C.B. has provided €90 billion of liquidity to Greek banks”

    These numbers are incorrect. I don’t know where they come from. Maybe he was including private exposures.

    The ECB’s/Eurosystem’s exposure to Greece consists of

    – Direct bond holdings as part of the Securities Markets Program. The aggregate volume of the program is about €78 billion, some fraction of which is Greek paper. Bought in secondary markets and valued at market price at purchase, not nominal price. A big haircut would certainly cause losses on this part.
    – Monetary policy operations vis-a-vis Greek banks. Again unpublished, but a good approximation is “liabilities to MFIs in other euro area countries” in the Greek central bank’s balance sheet. This stood at €83 billion in April. As I said, these are secured and relatively safe.
    – Some Greek bonds in national central banks’ own portfolios. Unreported but small.

  76. @ John McHale

    “What I am groping towards is a way to prise open the window back to the markets.”

    Sooner or later I’m going to write a little essay on the uses of metaphor on the Irish economy. We have, “kicking the can”, “the nuclear option”, “twin pillars”, endless varieties of the Titanic, etc.

    Strong images are very powerful, for good or for ill, in framing a narrative, and narratives can become sweeping, whether or no they are accurate. Iceland, Ireland and Scotland (all those Scottish banks), all went through a similar experience, yet the way they are playing out in the competing national images and narratives is quite distinct.

    On ‘prising open a window’, I don’t think that’s quite right – too much strain, and people don’t like to buy in to people who are desperate. It smacks of burglary.

    No good thoughts yet: but I would have thought that the markets are currently open to Ireland, but at prices at which the state doesn’t wish to sell. So it’s a two way street. If the house of cards (there’s a couple more) doesn’t fall, then there will come a time when it is mutually beneficial for bonder-buyers to buy and the state to sell. So whatever the image is for re-entry to the markets, it could do with being more transactional and mutually satisfying one.

  77. @Anonymous
    “So while Greek banks can still post Greek sovereign bills and bonds as collateral, these are valued at market prices and after that an additional haircut is applied.”
    Where do you get this from? I don’t see anything about it in the eligible assets document?

  78. @Anonymous
    Yeah, I’ve seen that, it’s just that as far as I was aware, eurozone sovereigns were not subjected to a mark-to-market haircut – they were assumed to be money good.

  79. @Anonymous, hoganmahew

    The Economist has an article that covers this topic.

    The way I read it is that collateral provided for bank liquidity is marked to market on a daily basis (even if that collateral includes sovereign bonds). Extra margin can be demanded if prices fall. On the ECB exposure:

    Of the various ways to restructure Greek debt, the most drastic (and least likely) would be to reduce its par value by 50%, bringing it down close to current market values for ten-year bonds. Even in this eventuality the ECB should still be covered, says Laurent Fransolet, an economist at Barclays Capital.

    For the SMP program securities were bought at market value but these will have dropped in value.

    Losses on the Greek holding in the programme from a 50% restructuring could be €18 billion, according to Barclays Capital. However, these would be split across the Eurosystem as a whole, with the ECB itself bearing only 8% of them.

    The overall conclusion is

    On the face of it, then, the ECB should be able to withstand losses arising from a default, even if it needed further recapitalisation by its NCBs. Its vehement objections to a restructuring may be as much about credibility as its assessment of the risks it faces. It intensely dislikes the label some give it of the euro area’s “bad bank”, a dumping-ground for dubious securities. The ECB’s campaign against restructuring springs more from worries about its authority rather than its capital.

    To me the the ECB’s objections to a ratings downgrade seem wholly artificial – i.e. something rated at CCC is perfectly acceptable, whereas something rated at D is the end of the world. It appears that nothing is accounted for at nominal value anyway, so I don’t see why a concrete recognition that the bonds are not worth par value should be used as an excuse to pick up the ball and go home in a sulk.

  80. @Hogan

    “Yeah, I’ve seen that, it’s just that as far as I was aware, eurozone sovereigns were not subjected to a mark-to-market haircut – they were assumed to be money good.”

    The treatment is the same. The ECB’s statute forbids any preferential treatment of public issuers.

  81. @ Hogan/Anonymous

    ECB mtm’s sovereign debt, as well as upfront haircut. The mtm works both ways btw, some of the high coupon bonds could easily be worth 110-115 cents, so there’s no way banks would be willing to use them as collateral without getting the full benefit of their mtm.

  82. @Anonymous/Eoin
    Thank you both.

    So if the ECB is MtM the Greek sovereigns and bank bonds etc. where is the risk? Surely that price is already pricing in a default for repo operations, so only the ‘bought’ amount is in danger.

    The bought amount was purchased at increasingly depressed prices (but above the current market price), so has the ECB not been writing this down on a continuing basis? Are they hiding it in Tier3? 😆 So they are a bank after all – stuffed with over-valued assets there’s no market for at a price they can afford…

  83. @Hogan

    Have made the point previously, the ECB has haircut as a risk management strategy. When you take assets for a repo you do so on the basis that you might end up keeping them.

    Karl W some time ago proposed a debt for equity swap with the ECB. My proposed scheme is the just-keep-your-collateral version.

    The ECB is at risk because it may not have applied sufficient haircuts on the repos, and it has provided a bid for banks (mainly) to exit positions in periphery sov bonds. The latter can be presented to Merkel and co as a bailout.

    It should be able to negotiate a recap – requested by politicians in respect of the purchases – as part of a default deal for Greece. If it has to get re-capped as a result of repos them that would be embarrassing.

  84. If bank A holds senior debt issued by bank B, then on the balance sheet of bank A is this asset held at par or marked to market?

  85. @ Hogan

    risks:

    ECB has two Greek risks – to outright purchases via SMP programme, and to repo collateral from banks (Greek and otherwise) using the repo window.

    1. dealing with the repo stuff first, if Greece goes belly up, this doesn’t automatically create a loss for the ECB. The mtm and haircutting only protects them so long as the recovery they get on the bond or the actual price they can sell the collateral in the market meets the price they have given out liquidity against. Also the counterparty aginst the repo transaction is important – if it’s Alpha Bank in downtown Athens involved, yeah, the ECB is looking at some losses, but if its BNP then they may not lose anything.

    2. SMP losses would be the bigger issue. ECB is believed to have around 45-50bn in Greek debt. This was primarily (80%+) bought in May-July period. Taking the 2016 Greek govvie as a good “average” bond, they would have been buying this at 75-80 cents. It now trades at 50 cents. Assume they got current market pricing, that implies a 35% or 16-18bn loss. Assuming an S&P predicted recovery value of more like 40 cents, that implies something more like 22-24bn loss. I’d assume they’ve been holding it at either par or at the purchased price. They said they would hold all bonds til maturity, apparently.

    @ Bryan G

    depends on whether they have stuck it in the banking book (hold to maturity at par) or the trading book (mtm). Both options available to them.

  86. @BEB

    Thanks – seems like the difference is important from the point of view of “contagion”, since in one case it could lead to the need for immediate recapitalization, and in the other case not.

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