Monday 9 January 2012

Questions and Feedback on the PSI proposal

I have received a lot of constructive feedback on the PSI proposal. (Read Dr Lambropoulos article in Many market participants raised questions regarding the proposal. In this sort post I clarify some of the questions I and possibly misunderstandings:

  1.   I am NOT proposing for Greece to offer to buy back the Greek bonds. It is NOT a tender offer to buy the bonds at a price or a Dutch auction process. 
  2.  Greece would NOT go into the secondary market and bid for the bonds. It would be imprudent to do so as it would immediately lift the prices. 
  3.  The proposal is simple. Just add to the current PSI the option to pay 30% (say) and destroy the bonds. Bondholders who wish to participate into the voluntary PSI would have the option to either get 30% (say) and get out of Greek risk altogether or get a new 30Y Greek bond (plus some cash upfront). 
  4.  The proposal also calls for the ECB to sell voluntary their holdings back to the issuer (Greece) at 70% (it could be 80% or the level that minimises ECB losses). 
  5.  The different prices between the Private and the Official sector does not present a legal problem as this is a voluntary sell by the bondholders to the issuer and not a differential tender offer. 
  6.  There is no need for a new EU council decision. The proposal is within the PSI process. It just adds another option for the bondholders to consider. Only the total amount would need to be updated. 
  7.  Where would Greece find the money? Answer: Once bondholders agree to sell their bonds the EFSF could issue a T-bill with maturities of 3,6,9,12,15 months (for example) to exchange the Greek bond with and spread the raising of the requisite 120billion over time. 
  8.  Doesn’t this proposal introduce moral hazard? In other words, Greece is off the hook and able to repeat the same ruinous policies as before? Answer: As it stands Greece would get 89billion once the PSI is completed. So obviously, this is not a major concern for policy makers. In addition, even after the completion the Greek Banks would still depend for their funding and recapitalization to Europe. Moreover, the strict conditionality already imposed onto the Greek government would probably suffice. 
  9.  What is going to happen to the Free Riders? Answer: Once the ECB is taken out, then only the bravest of the brave would remain as free riders. Most likely, holders of very near maturities. This is a classic game theory problem. If too many hold out then Greece could make the threat of CAC’s or default real and thus force them. If on the other hand too few remain, then Greece may decide to leave them rather than cause credit event. This is the same problem that the original PSI is facing. By adding the full cash option (at 30%) and by taking the ECB out the PSI maximizes the participation. 
  10.  Would the addition of the cash option push the prices up? Answer: Once the option is announced prices would probably move close to the cash offer. In other words prices much lower than 30% would probably converge as investors buy them (say at 20) to sell them back at 30. 
  11.  The proposal would not cause a credit event as it is part of the voluntary PSI. Greece would most probably be placed under “Selective Default” for the time period till completion.
 Hope this helps to clear up some of the misunderstandings.