It was the G20 over the weekend in Mexico but it could have easily have been yet another EU summit in Brussels. Much of the G20, led by the United States, Canada and Japan, pressured Europe to do more to build economic firewalls to contain the current crisis while Germany stands firm on its refusals.
And so begins the circular arguments. The IMF wants to raise an additional $US600 billion to help contain Europe, but other IMF members are refusing until Europe, specifically Germany, does more. Europe, however, has lost the political will to increase the size of the European firewall (ESM/EFSF) and so has been seeking contributions from IMF members.. and around we go.
The G20 has been focussing on combining the EFSF and the ESM to provide a mechanism of approximately 1 trillion euros. As I have noted previously, this sounds like a lot of money but when you dig a little deeper you realise it is mostly the same ‘European solution’ rebranded under a different title with very little actual money involved.
The idea of combining and enlarging the two mechanism has previously been blocked by some members of the Eurozone, including Germany, and that position appears to have been re-iterated at the G20.
From German Finance Minister Wolfgang Schaeuble:
“Let me be clear: it doesn’t make any economic sense to follow the calls… for endlessly pumping money into the rescue funds nor setting up the ECB printing press”
“All of this would not help countries to overcome their problems in the long term and restore calm in the markets, No, this would create disincentives for countries to carry on consolidating and reforming and would not improve the eurozone’s economic outlook.”
There has been some talk that Germany was more flexible behind closed doors but in true European style Germany has now stated it will postpone any decision until later in March.
Over the weekend we also saw Greece launch its bond exchange deal and an associated website. The new deal has some new details, most notably there is no actual cash involved. Whether this is due to timeframe or concern about the EFSF’s ability to raise the money is unknown but IMHO this exchange deal is even weaker than what was presumably agreed to just a few weeks ago.
The crux of the deal is that as a bond holder you would “voluntarily” hand in your Greek government bonds and in return receive:
- A GDP bond, which will pay 1% p/a of the face value of existing bonds for any year in the next 28 that Greece’s GDP rises above a set level. Current value unknown, but likely to be close to zero.
- A new 30 year Greek bond with a variable return at 31.5% of face value of the originally held bonds. The final coupon is unknown however there is a promise to pay 2% until 2015, then 3% until 2020, then 3.65% in 2021, and then 4.3% until maturity in 2042. This means that if you currently held €1 million of Greek bonds you would be receiving just €6,300 per year for the next 3 years and you won’t see the promised €315,000 in full until 2042 even if you happened to have previously been holding a bond that paid out in 2014. It is unknown what the current value of these bonds is, but market estimates put them at around 11% of current face value.
- A two-year bond from the EFSF worth 15% of the current bonds. This is in lieu of the original cash, but luckily the market still has these valued around face value on a 2 year maturity.
So if you held €1 million Greek bonds today, no matter what their maturity, at swap you would receive approximately €450,000 worth paper with the bulk of it maturing in 30 years. This means that you would not be able to realise that value, if at all, until 2042. So at exchange the value of the paper is nothing like its face value. Under current market estimates what you are actually receiving is paper worth around €260,000 or a 74% loss.
Can Greece achieve the IMF’s target of 95% participation rate with this deal? Given Argentina’s experience I suspect not, but the real question is can it achieve the required 75% participation rate in order for it to implement collective action? If it cannot then without further external help the deal is sunk and Greece will explicitly default. We’ll have to wait to find out if Greece can reach the target but, given the large write-downs from the big European banks, they already appear to be on board.
The deal itself sounds fairly good for Greece, but in reality the new paper makes it just more difficult for Greece to default in the future. The new bonds will be written under UK law which, along with the EFSF paper, have far more “creditor friendly” terms than the previous Greek-law bond. Together with unconfirmed news that creditors may have access to Greece’s gold reserves makes Greece’s entrapment in the euro just that little bit tighter.
In other news, we see the bundestag vote on the Greek bailout tonight and it is stage II of the ECB’s LTRO this week with market expectations that between €350 and €550bn will be handed out in return for the bank’s baseball card collections.