The Latest Greek Deal – Another Indictment of Intergovernmentalism

This will be a short one about the latest example of the uselessness of intergovernmentalism

So after two failed attempts at finding common ground on Greece on November 13th and on November 20th, the Eurogroup finally came to a provisional agreement which cheered the markets to the point where Italian bond yields continued to fall at their auctions on Tuesday and Thursday. But how good is this deal?

Well the problem at the moment is that Greece has done everything that was requested of it and still failed to meet the fiscal targets, because GDP being what it is, this negative procyclical vicious cycle isn’t really creating the growth that might have been dreamed up by policy makers. Revenues fall and the deficit isn’t really improving as much as initially expected. Rather the contrary…

In order to attend to this, and maintain a semblance of control over Greece’s debt path, the IMF has recommended that Greece’s debtors take a haircut on their holdings, which is standard procedure. Unfortunately, at this stage the majority of Greek debt is held by Euro-zone sovereigns and by the ECB, neither of which is as willing to force a haircut as it was in February, now that they are the ones left with the bill. As a result the IMF insisted and Juncker and Lagarde clashed publicly when the previous round of negotiations on the disbursal of the latest tranche of the Greek bailout failed to reach a conclusion.

So what solution was found? The table below leaked to the FT and from the FT to us, sums it up pretty nicely:

There are some things that did not get the attention that they deserved. So I should highlight that foregoing the T-Bill stock reduction was a very helpful move, as was the post-ponement of the build up of the Greek treasury’s cash buffer. However, I take issue with two other issues.

My first complaint is about the voluntary transfer of SMP profits to national treasuries and from there back to Greece. This matters because it is meant to provide the funds to reduce the deficit.  It refers to the fact that the ECB bought Greek debt at a discount, because the market was dumped it when Trichet sent in the SMP to try to help, unsuccessfully. Because the ECB is not in the business of making a profit from the misery of Greece, while simultaneously not being able to take a haircut, a compromise was found where the ECB takes the difference between the par value that the Greek sovereign pays and the discount price at which it bought the tickets and transfers it back to the respective national finance ministries, according to the ECB capital key. That’s all good and pretty but the NCBs cannot be forced to do this, so this is a non-binding decision, the completion of which is completely voluntary. The conclusion: It’s obviously a non credible commitment! More importantly, it is a part of the deal that is already falling apart. Today the Bundesbank made abundantly clear that it would not be able to transfer the 100% profits it would make on Greece because of risk reserve provisions. So no cigar…

My second quarrel is with the debt buy-back. Contrarily to Schauble’s optimism, I doubt that it will work. The first reason is that the majority of debt that is still held by the private sector is relatively long term debt, so there’s little short term relief that will be provided by this. The second concern is that investors are already bringing up the price in secondary markets, in the hope of getting a good deal. The result: Prices are no longer 20-something cents to the euro but rather 30-something. Again, a debt buyback is a voluntary deal. Investors will not accept it if they believe they can get more. The disparity of expectations between Euro-Zone leaders and bond holders should result in a bad outcome for the debt buyback.

But is any of this new? Not really… We’ve known Greece was stuck in the mud at least since February. If you didn’t know, it’s because you missed the confidential DSA report leaked by the FT back then showing this quite well.

So what’s going to happen? Reactions were positive. Danske bank for example concluded that the tentative agreement symbolised a shift in attitudes towards Greece in favour of doing all that was possible to keep it in, rather than to force it out of the Euro. As a result they concluded that the probability of a Greek exit was extremely low. This is of course in clear contrast with Buiter’s earlier prediction, but I have to say that I agree. I can’t quite remember when it was, but sometime around the end of the summer, Merkel’s rethoric changed and I remember her putting her party and her coalition partners in their place. Of course it’s a matter of timing. Germany probably won’t be able to go along with anything generous until the elections in September. Until then, there’s the December 14th deadline.

Either way, last monday was a lot of hot intergovernmentalist air, which the markets gladly swallowed. I won’t hammer the point further, but it is not unlike the flip-flopping about the automaticity of bond market intervention and the legacy assets that followed the June EU Council meeting…

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