I have posted some thoughts on the potential Greek referendum over at the IIEA’s blog.
“We have faith in our citizens, we believe in their judgment and therefore in their decision,” Mr Papandreou said after rejecting a call for early elections by some socialist politicians. “All the country’s political forces should support the [bail-out] agreement. The citizens will do the same once they are fully informed.”
Does he believe this? What are the implications for the euro?
Someone asked me today how a Greek-style haircut for private bondholders would impact on the Irish debt situation if applied here. Without any claim that this is a prediction for what could happen to Ireland, or a policy recommendation, here are the calculations.
While the figure grabbing the headlines is the 50%-60% haircut for private holders of Greek sovereign bonds, it appears that the bonds bought by the ECB will not be written down, nor will the IMF loans. FT Alphaville discuss a UBS report that calculates that a 50% haircut for private bondholders actually implies a 22% reduction in total debt.
In Ireland’s case, the latest EU Commission report estimates (page eight) that our year-end general government debt will be €172.5 billion or about 110 percent of GDP. The report also estimates that by the end of this year, we will owe €38.2 billion to the EU and IMF. (Table 4 on page 23).
We don’t know how much Irish sovereign debt the ECB own but it’s believed to be a large amount. I do remember a report from Barclay’s claiming they owned €18 billion by June 2010. Let’s say ECB owns €22 billion of Irish debt (that’s just a guess, I really don’t know). Combine that with €38 billion from EU-IMF and you have €60 billion in debt that wouldn’t be getting a haircut. Better guesses of ECB holdings of Irish sovereign debt are welcome.
Now apply a 50% haircut to the remaining €92.5 billion of our debt and you reduce the debt by €46.25 billion, or 29 percent of GDP, getting the debt ratio down to 81 percent. (Of course, we’d still be running large deficits, so it would start increasing again.)
So that’s the answer. Perhaps worth noting, however, is that an alternative method of writing down Ireland’s debt by close to 30 percent of GDP without haircutting private bondholders at all would be to have Anglo’s ELA debt to the Central Bank of Ireland written off.
According to its interim report Anglo owed €28.1 billion in ELA at the end of 2010 but this had risen to €38.1 billion by the end of June. This is because Anglo transferred €12.2 billion in NAMA senior bonds to AIB in February to back the deposits that were being moved out of the bank.
On July 1, Anglo was merged with Irish Nationwide Building Society (INBS) to form what is now called the Irish Bank Resolution Corporation (IBRC). As of the end of 2010, INBS had €7.3 billion in loans from the ECB. However, €3.7 billion of this was backed by NAMA bonds and other assets that were transferred to Irish Life and Permanent. INBS has been in receipt of ELA since February to replace this lost funding. While this has been admitted by a Department of Finance official (see this story) the exact figure has not been released. I assume it is about €4 billion.
So my estimate is that the IBRC now owes about €42 billion in Emergency Liquidity Assistance to the Central Bank of Ireland. If the European authorities ever decide they like the idea of haircuts for Irish debt, it would be fair to ask which of a fifty percent haircut or a write-off of ELA would be more likely to damage Ireland’s reputation or cause financial market contagion.
European politicians are engaged in frantic negotiations to deal with both the Greek debt problem and the wider question of the EU’s approach to the problems of peripheral countries.
On the approach to the Greece, I’m not encouraged by the reporting from the financial press which has focused on a bank tax and debt buybacks.
First, we’re being told that the idea of a tax on European banks to raise about €30 billion is emerging as a “popular consensus” approach to getting private creditors to “help pay for the estimated €115bn bail-out”. As reported, it’s pretty unclear what happens with the €30 billion. Is it loaned to Greece and then later paid back to the banks that paid the tax? If so, it’s not really a tax in the usual sense of the word. Anyone who understands this is welcome to explain it in comments.
However it’s structured, this seems to be the wrong approach to the wrong problem. The goal seems to be to keep Greece’s debt burden exactly where it is (thus not solving the key problem) but to reduce the headline number for the size of a second EU-IMF loan (which solves a political problem in some countries). In relation to private sector “burden sharing”, the approach still seems to view a Greek default as unthinkable (despite almost everyone viewing it as inevitable) while adopting a very strange approach to the demand for “private sector involvement”: Why should banks that don’t own any Greek debt have to pay a tax to contribute to a second bailout?
Maybe there’s a good idea hiding under this reporting: If so, I’m happy to have it explained to me.
Then there’s the increased focus on debt buybacks. The idea of debt buybacks is popular with both politicians and holders of debt. The politicians get to claim that there was no coercive default on the outstanding debt, thus saving face. The creditors usually manage to get the debt bought back at a nice premium to the current market value, so many of them make a tidy profit.
Academics that have looked at this issue generally don’t like debt buybacks. Here‘s a short article from VoxEU by some IMF staff. And here and here are two classic older articles written in the context of the 1980s Latin American debt crisis.
To briefly explain why buybacks are not as great an idea as they appear, consider the case of a country with debt and GDP of €100 billion, so the debt ratio is 100%. The market doubts this debt burden is sustainable and so prices the debt at 60 percent of its face value.
Now a programme is announced whereby funds are provided to allow the country to buy back all its debt. Those behind the plan imagine they can go into the market and start purchasing debt at 60c and get the debt ratio down to 60%. However, because the debt ratio would be sustainable at 60% and at that point the government would be able to pay back all of its debts, there would be no need in such a situation for there to be a market discount on the price of the debt.
So, as the programme is announced and the government intervenes to start repurchasing its debt, the price of the debt would jump above 60c. The final price of the debt would depend upon a number of factors including the terms on the money being provided externally to fund the programme. But the end result would probably be significantly less debt relief than obtained, for example, by a straight swap of new for old bonds involving a forty percent reduction in net present value.
In relation to the wider Euro area problems, I’m somewhat optimistic that Thursday will see a harmonisation and reduction of EU programme interest rates, extension of maturities, as well approval of EFSF loans for debt buybacks. Personally, I would like to see the remit of EFSF extended to allow it to lend directly to banks, replacing excessive ECB funding as well as Emergency Liquidity Assistance. Of course, I doubt if this is even being considered.
We’ll see what happens but my prediction is that political face saving will take precedence over economically efficient solutions.
Update: The FT has an answer to my question about the bank tax which mixes it together with the buyback plan: “According to officials, it would amount to a 0.0025 per cent levy on all assets held by eurozone banks and would raise €10bn per year for five years. The cash would go to the bail-out fund, which would then use the money to conduct a Greek bond buy-back.”
It’s being discussed in the comments already but it’s worth giving German Finance Minister Wolfgang Schauble’s letter to the ECB, IMF and Ecofin ministers its own thread. The key proposal:
This means that any agreement on 20 June has to include a clear mandate — given to Greece possibly together with the IMF — to initiate the process of involving holders of Greek bonds. this process has to lead to a quantified and substantial contribution of bondholders to the support effort, beyond a pure Vienna initiative approach. Such a result can best be reached through a bond swap leading to a prolongation of the outstanding Greek sovereign bonds by seven years, at the same time giving Greece the necessary time to fully implement the necessary reforms and regain market confidence.
Just to be parochial about this for a minute, this raises an interesting question. If this approach was implemented successfully and did not trigger a financial crisis (I know some disagree — this is a hypothetical question) what are the chances that a similar restructuring would not be part of any potential second EU-IMF deal for Ireland?
With things heating up in Greece, Lorenzo Bini Smaghi today outlines his case against debt restructuring in Greece. He argues four points:
First, as I already mentioned, it would not be a way to prevent taxpayers from suffering the consequences of bad investment decisions. In our Monetary Union, given the integration of financial markets and the single monetary policy, the taxpayers of the creditor countries would suffer in any case. According to the Financial Times, for instance, a default on Greece’s debt would cost the German taxpayers alone “at least €40 billion”.
Second, this would be a way to punish patient investors, who are sticking to their investment and have not sold their bonds yet, and are confident that with the adjustment programme the country will get back on its feet. Restructuring would instead reward the investors who exited the market earlier or short-sold the sovereign bond, speculating that they would gain out of a restructuring.
Third, it would destabilise the euro area financial markets by creating incentives for short-term speculative behaviour. Given that markets are forward-looking, they would try to anticipate any difficulty faced by a sovereign by short-selling their positions, thus triggering the crisis. This would discourage investment in the euro area because of its potential volatility and perverse market dynamics.
Finally, such a measure would delay any return to the market by a sovereign, because no market participant would be willing to start reinvesting in the country for a long period if they know that this kind of investment might at some stage be penalised. This would thus discourage private sector involvement and oblige the official sector to increase its financial contribution.
These don’t strike me as very strong points.
On the first point, well yes “taxpayers” in Germany who own Greek bonds will lose out but the bonds are already trading at a huge discount to face value so, for many, the losses have already been taken and the price of the bonds factors in a restructuring.
The second point amounts to saying we should reward people who make wildly inaccurate judgments about the Greek macroeconomic situation, i.e. those who “are confident that with the adjustment programme the country will get back on its feet” should be rewarded. Should those investors who believe in Santa Claus get cheques from the EU and the IMF at Christmas?
The third point that investors would look to sell sovereign bonds of peripheral countries in anticipation of a restructuring appears to ignore that this has already happened. For example, Irish sovereign bond pricing is based on the assumption of a restructuring.
The final point, that a restructuring would delay Greece’s return to the market is debatable. Even if debt ratios stabilised over the next few years, private creditors will still see huge risks. A restructuring that restores sustainability, however, would be more likely to restore access to private bond markets.
If these are the best points the ECB have, you can see why they’re losing the argument.
The governments will give Greece new lending, to be provided by the European Financial Stability Facility, the euro zone’s sovereign rescue fund, officials said. But that financing will likely come with the condition that the banks, pensions funds and other investors holding Greek bonds agree to exchange them for new bonds with a longer maturity to help fill Greece’s financing gap over the next three years, they said.
“Private investors would have a strong incentive to participate, because if they don’t, there will be a default,” said one official.
It’s the Don Corleone approach to default negotiation, involving making people offers they can’t resist.
Still, providers of CDS insurance will be thrilled to hear that
the debt-exchange process envisioned by the governments won’t rewrite existing bond contracts or trigger a credit event, the officials said, partly easing the ECB’s concerns that private creditors are being forced to contribute financing.
Can someone explain to me why it’s so important to the ECB or any government whether a restructuring scheme constitutes a credit event for CDS purposes? Are the firms that offer this insurance somehow more important sources of systemic risk than those who own Greek sovereign bonds? Or is it more for the appearance of purity — “it was not a default, now way, sure the CDS guys say it wasn’t a credit event”, that kind of thing?
Anyway, what odds are there now that holders of Irish sovereign bonds will walk away unscathed?