Monday 12 November 2012

Helping Greece. The options.

In many ways the Greek government managed to deliver in its promises. The 3rd in line MOU was voted with 153 out 300 MPs and the budget was passed with even greater majority. Now all that remains is to see the resolve of the coalition to implement the law and save Greece from exiting the Eurozone. Europe must now stop playing games on the back of Greece. It is increasingly worrisome that Europe hits the “Greece crisis” button every time there is danger in Spain or other European countries. It seems that Greece is being used as a decoy in the war to deflect attention from the more significant problems of Spain and Italy. The so called sustainability of debt analysis is just a load of gobbledygook. None of the forecast or scenario analysis that was done materialized. In fact, most analysts and even policy makers knew that the PSI restructuring was not done to make the Greek debt serviceable. In any case, it was done and now we are back were we started. So what next? Another haircut to the post-PSI bonds? An OSI restructuring? A “silent” rollover of the debt? Here we look at the options.

Increasingly we see articles and studies on the unsustainability of the Greek debt and there are many calls apparently both from the IMF and other policy makers on restructuring the official sector loans. One must be very clear on the level of debt that Greece can sustain. Many report that a figure of more than 160% or 180% is unsustainable. This is not true. Sustainability is not just a function of dividing the nominal debt by the GDP number. It also depends on the maturity profile and of interest rate burden. As it stands most of the Greek debt matures from 2022 up to 2042. There are some left overs (ECB holdings and IMF loans) but the bulk is 10y away or later. Currently Greece is paying an average of 3-4% on this debt. In order to help Greece it would be better to give a few years grace period on interest rate payment and roll over the ECB rather than instigate a haircut on the OSI.
 Another idea that has gained some momentum is to buy back the already restructured Greek bonds. i.e. the post PSI bonds that currently are trading at around 25% of their nominal.
Back in January and February of 2012 we presented an alternative to the PSI restructuring offer. The idea was published by GreekEconomistsforReform and was also presented in an LSE Debate, AndreasKoutras. It was also send to main policy makers in Europe and in Greece with very interesting responses at the time.
The main idea was to include the option of selling back the Greek debt to the Greek government at 30% after buying back the ECB holdings at cost (54Billion bought at around 75%). The main argument was that after taking out the main free-rider (The ECB) at cost, investors would have no incentive to hold out and would prefer to receive 30% (or thereabout) cash in hand rather than redemption in 30y (new PSI bonds). This would also exclude the danger of another restructuring down the road.
Our calculations showed that by taking the ECB out at around 75% would cost 40billion and buying back 90% of the rest would result in a debt to GDP of around 115% from day one, even after accounting for the recapitalization of the Greek banks. The plan was send to many policy makers in Europe who politely answered that “the PSI was the sole responsibility of the Greek government and the European commission had no saying in it”!! Others were tacitly positive but powerless to react to the PSI momentum.
The truth is that the plan to buy the debt back had no chance of success for two reasons. First, the wheels of Europe and of their bureaucrats were dancing in the PSI tune and had no interest in hearing anything else. Second, the plan required more money upfront as the buying had to be completed in 12-18months. Perhaps a third reason was the real intention of the PSI restructuring. It was never about reducing the Greek Debt to GDP but about punishing the markets while at the same time immunizing the threat of Greece. From this point of view the PSI succeeded. A financial default currently would have no direct impact in the financial markets. The danger is now political and not financial.
In any case, the sell-back plan never happened and we are now 8 months after the so called successful PSI wondering if a buy-back of the post PSI bonds could help reduce the burden for Greece. It is perhaps for this reason that the head of the IIF Mr Dalara is visiting Greece. Let us look at the numbers.
There are about 65billion of post PSI bonds that are currently trading at around 25% of nominal. A naïve calculation done usually by politicians is that with 16.25billion (25%*65) Greece can buy the bonds back and destroy them resulting in a 48.75billion reduction of debt. This is a sizeable reduction. There are however some technical problems with this strategy. First it cannot be performed in the open market. Namely, Greece or the EFSF cannot go in the market and start buying these bonds. The daily liquidity is barely 100million. Attempting to buy bulk would push the price up and would diminish the benefit. The market would know weeks in advance of the intention as the EFSF or ESM would have to raise the funds to buy the Greek bonds and it would reprice upwards the bonds accordingly. The only other option is for Greece to make a proper buyback offer to the bondholders at a higher price (say around 40-50% or more) contingent on a certain threshold amount being satisfied. This, together with political pressure on the European banks that hold the Greek debt might yield some results. We do not know how much of the Greek post PSI debt is still in the hands of European banks amenable to gentle pressure from Schauble but anecdotal evidence point to buyers from the US the past few months and not Europeans. In other words, much of the post PSI may be in non-European banks.
By far however, the biggest issue is the fact that these bonds are rather safe for investors to hold. They are under English law and apparently rank Pari Passu with the rest of Greek indebtness. This means that the threat of non-payment by Greece is not very credible. Greece can no longer unilaterally change the bond terms like it did with the Greek law bonds. Imposing a moratorium on payments would mean legal challenges across the world, something that Greece and the EU might want to avoid, especially after the recent rulings on US courts against Argentina and on English courts (Collective Action clauses interpretation).
In addition, servicing these bonds that have a 2% coupon only burdens Greece by 1.3billion a year. This is a rather small amount of cashflow savings when one sees the dangers that it entails.
Thus the only other option is the Official sector holding.
ECB holdings
There are few ways in which the Official sector and in particular the ECB can help Greece alleviate some of the debt burden. One that has been ruled out completely is to haircut the bonds in accordance to the PSI. Another idea is to exchange the ECB holdings with new bonds of longer maturity. This too has been deemed monetary financing, and thus ruled out. Selling them back to Greece at cost is another option that would require finding around 30billion with a gain of only 10. However, there is one option that can be done without violating the Treaties and is being done all the time.
Solution: Allow Greece to issue T-bills to pay for the 18billion of redemptions in 2013 and 2014. Greece simply issues the T-bills that are bought by Greek or other banks which in turn they put them as collateral with the ECB (or ELA) to obtain the funding. In this way, the ECB is getting repaid and the debt can be rolled over for few more years till Greece can pay it.
For this to happen the ECB should allow the extension of the T-bill limit. In doing so it would give Greece the necessary breathing space to effect reforms on a more sustainable basis.
NPV restructuring the Official Sector
The only other option that is politically edible is to restructure the OSI loans by giving Greece a grace period of 5Y on the interest payments. Haircutting the principal amount is not something that can be done now so the best option is to capitalize the interest and make it payable in 2042. This would give enough leeway to Greece to ease the recessionary effects of rapid cuts. 
If Europe wants to help Greece they must release the 31.5billion in order for the Greek banks to be recapitalized and give the economy a fighting chance. If Europe is sincere in helping Greece overcoming their problems they should also give a grace period on interest rate payments conditional on reforms and targets to be met. That would be the best incentive for Greece.