Monday, 19 December 2011

Should Santa bring PSI to the Greeks?

Letter to Santa,

Dear Santa, I am the Greek government and I know that I have not been a very good child lately. I was placed on the naughty step many times this year for not behaving properly. Despite my parent’s good will and encouragement I did not manage to reduce significantly my addiction to the soviet style state, I did not brake relations with my good friends the unions, or increase my rather poor grades in housekeeping. I also failed to share some of my prized toys and possessions with other kids. I know, “If you do not share (sell) you do not play” but I really can’t. I realised that my finance minister behaved rather impolitely to your representative elves, but he has now learnt who is filling his dog bowl with goodies and realigned his allegiance accordingly.  He realised that our benevolent parents assign the top dog position. Although I cannot claim to have repented in full, I did change the Prime Minister as instructed by our well-meaning parents. I reluctantly formed a unity government consisting of some right wing xenophobic fascists, hysterical nationalists and utopian socialists. Although this is not the ideal, it is the absolute best, the crème de la crème, of the Greek political system. So, please, please, please can I have my PSI for Christmas? I promise to be good going forward.
Greek Government


The original PSI back in July, asked for a Net Present Value loss of 21% assuming an exit yield of 9% for the Greek bonds. That was a truly bad solution for Greece as we quickly pointed out in our letter. It did not alter the dynamics or the sustainability of the Greek debt at all. In fact the whole idea of the PSI is bad. It is for this reason that the decision was taken last month of abandoning the PSI going forward. For Greece though, they did something different. They not only kept it, but also managed to make the PSI really bad both for Greece and the bondholders. Let's see how they managed this feat.

PSI is bad for bondholders who have already taken the pain
Restructuring one’s debt is a high art. You haircut too little and there is no benefit to the issuer. Haircut too much and bondholders have no incentive to accept you offer. The original 21% NPV loss would not have made any significant improvement to the sustainability of the Greek debt. It was therefore good that it was abandoned. The current one however, swung the other way. By insisting on a nominal haircut of 50% and at the same time insisting rather perplexingly to be voluntary they completely altered the incentives.
Most but not all the European banks have already taken the hit and marked their GGB’s very close to the market value (25-50). This means that they have already taken the pain. It is a sunk cost. Example:
GGB 4.6%, May 2013 is trading around 30%. Assume further that a German bank has marked it at 40%. The bank is now given a voluntary choice of entering into PSI with 50% nominal haircut and further NPV haircut of unknown proportions. This is because the T’s (Terms) and C’s (Conditions) of the new bonds are not known. Assuming another 20% NPV (20% of the 50%) loss it would bring the new Greek bond at 40%. What happens though if the trader decides to hold out. He risks being coercively restructured, in which case he may get recovery between 30-40% or he may get his full money back (100%). Any trader will tell you that the risk return profile is highly skewed towards free riding (Holding out) like the ECB. You can read further on the joys and thrills of free riding.
Thus anyone who has either bought his GGB near the current market value or has taken the cost and has marked them close to market would be better off holding out, in brotherhood with the ECB and the official sector.
Furthermore, giving the already burned bondholders again Greek risk (bonds) for another 30Y (with or without principal guarantees) would be a nightmare for all of them (risk managers, traders, accountants and Basle regulatory capital charges)

PSI is bad for Greece. Punishing Bondholder is not in the interests of Greece

Greece may be asking Santa for a PSI present, but as they say, “be careful what you wish for”. To be honest, this is not what Greece wants, but what Merkozy ordered Greece to want. Greece as far as we can tell, never had a policy on how to manage its own liabilities or any inclination to form a coherent strategy to tackle the problem. They Greek government combined happily, ignorance incompetence, and incapacity.
Germany wanted the PSI as a means to punish the private bondholders. In fact the market through the price action has punished them far more than the insane PSI. Punishing the bondholders however, is NOT in the interests of Greece. Greece should only care about the exit yield, the exit rating and the sustainability of its cashflow.
Exit Yield: This is the yield at which the Greek bonds would be trading after the restructuring.
Exit rating:  This is the rating that agencies would assign after the restructuring has taken place
Sustainability: Would Greece be able to pay for herself after the restructuring?
Unfortunately, the PSI in its current form fails to deliver all three. This is because the bondholders demand very high coupons that negate the sustainability, exit yield and consequently the rating. In fact, Greece currently still runs primary deficits with and economy on a free fall. It is highly improbable that Greece would be able to pay any coupons in the next few years without further borrowing. Add to this the contentious issue of the new bond’s Jurisdiction. Bondholders demand English law.

English Law Jurisdiction. Germans demand the protection of the English!!!

What is the probability that the new Greek bonds given after the PSI, would need to be restructured again? Any unbiased observer would say more or less 100%. Which is why German bondholders demand English justice. One cannot help but giggle at this. Germany, and in fact the rest of the Eurozone, accepts that the English law and courts have far more weight, knowledge and experience and offer more protection than their own justice systems.

Only Alternative is to Buyback

There is however, and alternative that is attractive to both Bondholders and Greece. That of a voluntary offer to buy the bonds backs at 35%. I say voluntary to keep with the PSI demands. After all, only bondholders that are amenable to European political pressure would participate in the PSI. Instead of giving them new Greek risk with English law, just pay them 35% and be done with it. What are the merits of this alternative?
·            Debt is reduced to around 120% day one. This is how:
o   ECB gets 70% on 50billion. Pay 35billion
o   From the rest (160billion) 15% stay out: Pay 24billion
o   Buyback at 35% of 136billion; Pay 47billion
Thus with 106 billion Greece can retire/service 205 billion. This would bring the total debt day one, at around 260billion or around 120% of GDP.
·            Greece would not have to pay anything for the next 10Y as these loans are subject to the Grace period.
·            Greece would not have to accept foreign jurisdiction in its bonds
·            Bondholders get cash and do not have to deal with the risk management Greek bonds again.
·            Bondholders have been punished by the market and not by some European decree.
·            Greece cleans up their bonds. Now it can be free to introduce new ones, with CAC’s
·            Greece should be upgraded as the old debt is destroyed and the sustainability of the Greek finances is improved by having the 10Y grace period.
·            Bondholders would not suffer any further losses or have their risk management departments ask for more provisions.
·            It would not be a Credit event! Greece may be placed under Selective Default for as long as the offer to voluntarily buy back is open. This is exactly what is going to happen once Greece makes a formal PSI offer.
Of course one may ask, where would Greece find the money to do this buyback. The buyback assumes that either the EFSF or the new ESM mechanism would provide the loans after the sustainability study.


The PSI was always a bad solution. It was one more mess introduced by politicians. The market has given its answer to both the PSI and is clearly pointing to the only real alternative for both Greece and bondholders. Buyback the bonds and stop the charade of the so-called negotiations.