The Greeks are starting to play hardball on their private sector debt swap warning the deal could crater if the 90 percent participation is not met. We think there are other reasons why it is trouble.
“If these thresholds are not met, Greece shall not proceed with any portion of the transaction described in this letter if it determines” there isn’t enough private sector involvement “to permit the official sector to support the new multi-year adjustment program.
Initially, we applauded the Greece deal as it was the first bailout that included the private sector, which has essentially been free riding on the back on the European taxpayer.
In fact, all of the bailouts have been a de facto attempt to recapitalize European banks, who would have taken massive hits in the event of defaults in periphery and collapsing the European financial system. The problem is, as far as we can see, the European banks continue to report decent earnings failing to take sufficient reserves against their sovereign exposure, which would painful, but necessary, and result in reporting losses. European banks are relatively thinly capitalized to begin with. Also see here.
Where is the European Banking Authority? Every euro the banks receive in backdoor bailout money as the periphery bonds mature and get paid by the European taxpayer should go into loan loss reserves. It appears some banks have just begun to take the hits and to allocate specific reserves against their sovereign exposure to periphery. Moral hazard everywhere!
After further analysis of the Greece debt swap we found the deal structurally flawed. Though the swap does reschedule maturities, Greece’s interest payment burden increases under the swap as the coupons on the new exchange bonds exceed the average interest rate the sovereign currently pays on existing bonds. In addition, the interest payments on the borrowing to purchase the zero-coupon bond collateral exceeds any small savings from the discounting of original principal.
The massive rally in 30-year bonds since the deal was announced has also complicated matters as the cost of a zero-coupon has increased almost 25 percent and now approaches 40 cents on the euro, which is almost the price at which Greek debt currently trades. Why, we ask, should Greece do this deal?
There is also much chatter about a Eurobond where all the debt of the eurozone is federalized. How about that for moral hazard? Why would a bondholder in tender to the debt swap if a Eurobond is on the horizon, which will pay the periphery debt in full? Unless, of course, one believes Europe is about to cut Greece loose or bondholders receive intense pressure from their home governments.
The European policymakers, along with their American counterparts, have lost credibility and the confidence of the markets. The intractable political problems and institutional constraints inherit in the eurozone prevents a solution to the debt crisis.
It’s time for the IMF, with the help of Asia, step up and play a bigger role in providing a comprehensive solution to the European sovereign debt crisis. We’re pulling for you, Ms. Lagarde, and the global economy is depending on you.