The Greek Saga Continues

Location Date: 
July 5, 2011

There is no question that markets are rallying now on the back of the proposed solution to the € 100 billion Greek debt (due in 2014) crisis. While almost every analyst / commentator realizes that Greece is in fact insolvent, there seems to be huge relief in knowing that this insolvency can be postponed for some period of time. The broader benefit to the “Dead Man Walking” scenario clearly lies with the European banking system, and in particular the various central banks, whose exposure to Greek (and other PIIGS) debt is the real canary in the coal mine. The contagion associated with the collapse of the debt – the required re-capitalizations of banks, the fall out from the pressure of the other PIIGS, etc etc would make matters far worse. So rather than have the banks assume some role/culpability for the mess, governments are working hard on “solutions” to bridge the gaps – unfortunately having the banks raise more capital or shuddering the cajas and other wards of the state are not part of the solution...yet. Instead, we are once again returning to the world of “off balance sheet” and creative accounting and structures.  Let’s take a closer look at the solution.

Wolfgang Manchau reporting in the FT the other day (Click Here) sums this situation up best.

As he states, “if you own a Greek bond that matures by June 2014, you keep 30 per cent of the redemption as cash, and roll over 70 per cent into a 30-year Greek government bond. The Greeks will have to pay an annual coupon, or interest rate, of between 5.5 per cent and 8 per cent. The precise rate will depend on future economic growth. Of the money received, Greece will lend on 30 per cent to a special purpose vehicle, another well-known construction from the subprime mortgage crisis. The SPV invests into AAA-rated government or agency bonds, and issues a 30-year zero coupon bond. The purpose of this is to guarantee the principal of the 30-year Greek government bond that you just bought. With this construction, the downside to your losses is limited. Depending on how some of the parameters of this agreement evolve, you will probably make a small loss, relative to the par value of your holding. If you are lucky, you might come out positive. You will probably not be lucky. But you will still be better off than if you sold today, or if Greece were to default. More important, the accounting rules allow you to pretend that you are not making any losses at all.”

Ironic or pathetic might best describe the Greek debt rescue plan’s proposed use of the good old CDO!  Of course this does not solve anything really – it does however buy time for the troubled nation of 14 million non tax paying souls.  In the interim, austerity will be imposed on the citizenry with the likely impact that the resultant falls in GDP (now expected to be -4% for 2011) actually exacerbate the problem. Add to the austerity program, proposed interest rates on the debt in the area of 7% will not help either. According to Manchau, this “dirty little con-trick” has everything to do with keeping the ratings agencies on side and the banks from taking any hits.  However, yesterday S&P said not so fast. Maybe once burned by bankers clever CDO’s, they are now twice shy.  But with the stakes so high in the short run, I expect the Eurozone politicians will come up with something to avoid a “technical” default to kick the can down the road.  The big question for investors is how long is the road and how toxic the can.  In the meantime, Portugal, Ireland, Spain, Italy….well, you know the rest.

Jim McGovern