I have completely failed to cover restructuring debate going on in the Eurozone. Let me try to do that now.
Restructuring: Origin of the Debate
Bruegel (inter alia) published a very good piece on this, back in February, where they estimated the assumptions behind the financing needs for the PIGs and found them laking in realism, particularly for Greece. The result was a confirmation of the otherwise already held certainty that Greece would have to restructure. The result was a shift in the debate on the Eurozone sovereign crisis from bailing out to (orderly) restructuring. This debt restructure has already started to occur, to some extent or other, both via Greece’s public agencies’ debt and via its debt to the EU. However, given the substantial holdings of Greek debt by the private sector, those early measures proved insufficient and so the talk progressed to feasible ways to bring them in, without triggering a “credit event” (Note: A credit event is a financial euphemism for “something everyone else considers a default”).
The Private bail-in: The Consequences
This private bail-in is more complicated than the previous tactics because of the way all of the legal, political, economic and financial pieces fit together.If there is some private restructuring , then the rating agencies must react. If they consider the form in which the private event took place to be equivalent to a credit event, then they will rate the sovereign in the appropriate manner.
Their interpretation and reaction determines not only the yields that the sovereign will face there onwards (huge!!), but also the availability of the ECB as a liquidity to the banks in that country. If they determine a voluntary deal to be akin to default, then the ECB cannot/will not accept Greek sovereign bonds as collateral from Greek banks who will then be unable to find the liquidity necessary to operate. There will be a bank run and the banking system, which is at present a zombie, will find its much postponed demise. Now of course the ECB is not legally obligated to reject Greek sovereign debt as collateral if it is rated as default. It is a matter of policy. However, it is a policy which the ECB seems to be sticking by quite vehemently. This is a game of chicken, where the ECB wants the member states to take the fiscal union step, which they are reluctant to do.
So which proposals have been advanced by public officials?
There is a rather long list. It could be a compulsory debt exchange (as championed by Schauble and Merkel until June 17). In this scenario, banks would exchange Greek sovereign bonds maturing in the Short-Term, for Longer-Term ones (up to thirty years).
It could also be a debt rollover scenario such as the Vienna Plus measure championed by the recent French proposal. In this scenario, private institutions (mostly banks and insurance companies) commit to maintaining their exposure to the Greek sovereign (the original plan, created in 2009, was to ensure that Austrian and Scandinavian banks maintained their exposure to the banking sector of Eastern Europe and the balkans) ( Notice that this was the proposal that the French went into the June EU Council with).
An then there is the “Brady bonds” or “Trichet bonds“. If I am not mistaken this is exactly the same thing as the above, but where the new Greek bonds are guaranteed by the ECB, rather than by the Greek sovereign. Now there are two problems with this. The first is the Moral Hazard problem. Although the conditionalities agreed with the EU/IMF are quite strong, their enforcement is only as good as their monitoring, and this external guarantee could create problems. Then of course, there’s a timing problem. By the time Brady bonds were agreed in Latin America, the countries had already started defaulting on their debt, which is what we are trying to avoid. So it is not as useful a tool.
Note how the differences between all of these proposals are more a subtle matter of form than one of strict substance. In the end the main difference is between whether the exchange/rollover, is enforced by the Eurozone on the banks or whether it is voluntarily pursued by the latter. No agreement is relevant that does not decrease the stock of debt of Greece, and this cannot be achieved without decreasing the assets of banks with exposure to Greece. So the substance will always be the same: A hit to the private sector’s balance sheet.
Then there is the proposal by JP Morgan, which prescribes a loan at subsidised (read lower) rates from the EFSF/ESM. The claim is that by providing cheaper loans with very strict conditionality, the debt path would realign faster and more credibly than in the present status quo. That’s a smart idea, which has already come into effect as the initial deals with Greece, Portugal and Ireland have been renegotiated, with longer maturities and lower interest rates. It’s bailout by stealth. These countries make a big fuss in the original negotiating process, for their domestic constituents. Once the deal is made, and they’ve locked into this policy path, they then discretely agree to lower the improve the feasibility of the deal. It’s a two stage game, played on two fronts (domestic and international) in the first stage and on the international front alone in the second stage. It’s not how things should be, but in the absence of appropriate tools (ie: Fiscal Union), I guess I would do the same.
Finally, there was an idea that floated around on June 20, that the EFSF would provide its own bonds to the Greek commercial banking sector, which could then be used as collateral in case their Greek sovereign bonds were no longer accepted by the ECB. I don’t really quite know how this would be implemented, but the idea was put forward at some point…
What’s to come?
Well S&P has already stated that it considers the French plan as a selective default and I believe Fitch also had some problems with a Vienna Plus initiative. At the same time the ECB has said it’ll take whatever the best rating is (also check this), so we go from there .
Roubini Global Economics offers a very good qualitative analysis of the possible choices available to Greece (it can be generalised to any country considering restructuring):
It’s “Greece: Restructuring Options by the Numbers” (makes for good reading if you can access it…) also gives a good insight into the quantitative effects and the exposure to the PIGs. Germany is the most exposed to all of them, particularly to Irish banks and to the Greek sovereign. Belgium is in second place with an abnormally high exposure to the Portuguese public sector. In third place comes France followed by Spain which is mostly exposed to Portugal.
Well we’ll see how it goes…