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Greek debt restructuring – a second reading

May 3, 2012

Published in ‘New Europe’, 25-31 March 2012, page 6

Screen Shot 2014-05-28 at 8.56.41 PMSo, Greece finally got its “credit event.” Was-it a bankruptcy though, or a “selective default” to use the rating agencies’ terminology? One thing is sure: the world didn’t come to an end, as was continuously argued by most of the financial media over the last two years. Neither did the euro disappear, nor was there a break-up of the European Union, as was written in countless articles by some of the world’s major newspapers.

Quite the contrary, we could say, financial markets reacted positively to the news, with spreads on the bond markets moving south, and the Dow Jones climbing to its highest point since 2007.

The story started in May 2010, when Greece was put under the tri-party surveillance of the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF), collectively referred to as the “troika”, and a bailout scheme was put in place. Under strong pressure from Chancellor Angela Merkel, the cost of saving Greece should be shared among the public and private sector, that is, among European taxpayers and the banks, through a mechanism that came to be known as Private Sector Involvement (PSI).

Throughout this period, the main concern of EU leaders was to avoid a formal default, so as to minimize the risk of contagion of the Greek crisis to other vacillating nations like Portugal, Italy, or Spain. An additional risk of the deal was the activation of Credit Default Swaps (CDS), that is the insurance contracts against default that some bondholders had bought. Instrumental to avoiding formal default was the provision that debt restructuring (the PSI) should be done on a “voluntary” basis.

Finally, in early March Greece called on its private investors to “voluntarily”  swap their Greek bonds for new ones, of longer maturity, lower interest rates, and take a “haircut” of 53.5 %. The deal concerned € 197 bn debt, the biggest debt restructuring ever done, and has saved Greece more than € 100 bn of its debt.

As initial participation quickly reached more than 90%, Greece felt strong enough to retrofit so-called Collective Action Clauses (CAC’s) into its under Greek law bonds (a practice which is legal under Greek law), to force all private bondholders (including those few who resisted) to participate in the restructuring. An important side-effect of the CAC’s was to make the deal look less voluntary in the eyes of the International Swap and Derivatives Association (ISDA), the market authority that supervises those instruments, which decided that the bond exchange procedure was in fact a “restructuring credit event”, triggering the payment process of the CDS, for a total of $2.5 bn— far lower than what was initially feared. This was the second time in history that CDS got paid (the first time was with the US insurance giant AIG), and in both cases under highly controversial triggering conditions.

That was the rescue plan for Greece, an issue that monopolized the headlines of the financial press over the last two years, and often created panic waves in the international markets. The Greek restructuring has serious implications for all those involved, Greece, Europe, and the markets.

For Greece, the rescue plan means that the risk of a “hard” or uncontrollable default has diminished, for now. Technically, Greece cannot default on its new debt, as maturities have been extended by 10 to 30 years (so, no principal to reimburse before 2022), and coupon payments are guaranteed up to 2015 by new loans granted by the troika. However, the remaining debt after restructuring is still high (currently around 160% of GDP), and chances to come down to a more manageable 120% of GDP by 2020 are slim, especially in the context of a “melting” economy (-7% GDP change in 2011), resulting from harsh austerity measures imposed by the troika to Greece in order to approve the bailout. The question is how long will the Greek people be able to withstand the pressure of this “internal devaluation” process, and how long it take them to react.

For Europe, the solution given to the Greek problem is undoubtedly a clear victory. Over the last two years, many have denounced the sluggishness of European leaders to agree on a solution, the delays of taking measures and creating a defense mechanism for the euro. Now, the Greek debt restructuring proves that the situation is (and probably has always been) under control. Contagion has been avoided, the euro remains unaffected by the Greek problem, the ECB has acted wisely by adding liquidity to the system when needed, and finally and most importantly, the Eurogroup has proved perfectly able to devise a solution to the Greek problem, by obtaining consensus of all its 17-members.

Finally, for the markets the message is clear — governments always have the final word, when general interest is at stake. And their arsenal is rather big: they can buy bonds in the secondary market, thus transferring part of the losses from the private to the official sector; they can retrofit clauses into contracts; they can force “consensus” among private investors. The lesson from the Greek restructuring is that finally markets do not run the world, political leaders still do.


From → Views & Opinions

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