GREEK DEAL WILL BUY TIME BUT HARD WORK LIES AHEAD / THE FINANCIAL TIMES MARKETS INSIGHT ( A MUST READ )

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Markets Insight
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March 7, 2012 9:49 pm

Greek deal will buy time but hard work lies ahead

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By Richard Milne

It is as complex as it is big. Greece’s €206bn debt restructuring has left people drowning in a sea of figures, struggling to make sense of the deal.


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Investors will get up to 24 new securities for each existing bond, a 66 per cent threshold for use of so-called “collective action clauses” but a 50 per cent quorum, and a participation rate that needs to be 95 per cent – or is it 90 or 70 per cent instead? Confused?


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The simple fact is that, for all its complexity, Greece has structured this deal so that it is likely to be reasonably successful. Retroactively inserting collective action clauses, which allow the decision of a majority of bondholders to bind all investors, may seem unfair to holdouts. But it all but ensures that Greece will be able to get all its Greek law bondholders to take part, giving it about 86 per cent participation.


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The question will then be to see how many international law bonds, which account for the other 14 per cent of the €206bn, are tendered in the exchange. It is unlikely enough will be tendered to reach the 95 per cent the International Monetary Fund has said is necessary to get Greece’s debt down to 120 per cent of gross domestic product by 2020.


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Greece has threatened not to pay any international law holdouts at all. That would open the way for a legal battle. But it also raises the prospect that Athens could raise more money than expected by simply not paying some bondholders.

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All this is enough to give anyone a headache. Indeed, many investors have largely switched off, suffering from a two-year-old disease called “Greek fatigue syndrome”. Others deride the deal as almost irrelevant as they believe Athens will have to default again soon to have any chance of getting its debt burden down to manageable levels.

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But the deal matters for several reasons. First, it is likely to serve as a test-bed for any future eurozone restructurings, despite protests to the contrary from policymakers.

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The 53.5 per cent debt relief Greece is expecting to achieve could well prove enticing to politicians in other indebted countries such as Portugal and even Italy or Ireland in the future, particularly when weighed against demands ever more austerity.

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Second, the deal is already in some ways determining the future shape of eurozone government bond markets, and not in a particularly healthy way. The issue of seniority is a big worry for some investors. The European Central Bank managed to get its €40bn-odd of bond holdings excluded from the swap in a move that irritated many investors. Then, the European Investment Bank also secured implied seniority by having its small holding taken out of the swap.

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Seniority of such institutions may matter little in good times. But, against a backdrop where international investors have left peripheral bond markets in their droves, the notion that there are bondholders alongside you who may suddenly declare themselves to be superior is an unsettling thought.

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The possible use of CACs is also something that investors in eurozone government bonds will have to get used to with all new eurozone debt due to have them inserted. That may be no bad thing, but their use in Athens shows how they introduce an extra element of credit risk for bond investors.

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Take a step and the big issues in the eurozone crisis remain unresolved. The debt swap only marks the latest step in Europe’s long-running strategy of trying to buy time.


True, closure of the Greek debt swap allied to the ECB’s cheap three-year loans to banks would give policymakers some breathing space. But, as a central banker from outside the eurozone says: “Buying time only works if you use the time for some purpose.”

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On that basis, the strategy cannot be declared a wholehearted success despite all the positive gloss from European leaders at this month's EU summit. They still need to ensure that the firewall to protect Italy and Spain, in particular, from contagion is as big as possible. Given the not insignificant chance that a combination of public austerity and recession could cause both of these countries’ economies to contract later this year, Europe cannot afford to be complacent.

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The danger now, even as Greece moves towards a deal with its creditors, is that the familiar narrative of the crisis reasserts itself: policymakers achieve something, markets relax, and policymakers lose momentum before the job is done. Investors have shown patience so far this year. But the foundations for the rally in Italian and Spanish bond markets remain fragile, with many international investors staying on the sidelines.


There will be relief should Greece pull off its debt exchange this weekend. But the hard work lies ahead for the rest of the eurozone.

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Copyright The Financial Times Limited 2012