23/6/15: In the parallel Universe of Greece: Strangulation is Cure

Greece has been 'repaired' with an application of yet another plaster to a gaping shark wound.

ECB hiked ELA once again, this time, reportedly, by 'just under' EUR1bn.

The terms of 'repairs' are sketchy for now, but for the economy that shrunk 23% since pre-crisis peak in real terms, we have novel - nay, breakthrough novel - measures to support growth included in the deal:

1. Corporate tax is rising from rather un-competitive 26% to highly uncompetitive 29%
2. Corporate profits in excess of EUR500K/pa are hit with 'solidarity' levy of 12%
3. Personal taxes are up, VAT is up, pensions levies are up, property taxes are up
4. Debt relief is not on the cards, as per Angela Merkel, the 180% GDP debt mountain "...is not an urgent question".

Summary of key financials on the 'deal' is here:

In short, we have an equivalent of economic idiocy here: an economy chocked by too much debt is being given a green light to get more debt. In exchange for this debt, the economy will be chocked some more (by some 2.7% of GDP on full year basis), so that more debt given to it can be rolled over with a pretence of sustainability.

As European leaders celebrate this crowning achievement of statism by replaying the same song for the 5th time whilst hoping for a different result. One has to wonder if there is something fundamentally, deeply, inexplicably wrong with the EU logic.

Or may be, just may be, the Greek 'reforms' are a herald of things to come under the Juncker-proposed, ECB et al approved, new Federalismo 2.0 plan? Why, check the leaks on that one: 

http://www.wsj.com/articles/new-eurozone-plan-calls-for-greater-economic-cohesion-within-currency-bloc-1434919204.

17/2/2012: ECB Swap Creates a New Structure of Seniority

This week marked a significant point of change in the very fabric of the fixed income markets. On Friday, the ECB announced that it has completed the swap on the old Greek bonds it held on its books for new bond.

The ECB swap in effect exchanged old Greek bonds for bonds of identical structure and nominal value, implying that the ECB has received the full face value of the bonds it has purchased in the markets at the discount on the face value. The ECB will also not forego the coupon payments due on the bonds, implying that over time, ECB will book profit from its purchases of Greek bonds. It is worth noting that this is based on the reports in the media, citing various official sources. The ECB has no inclination of clarifying any details of the transaction.

The ECB also precluded National Central Banks (some of which do hold Greek bonds) from participating in the swap. However, the ECB has signaled that it might (again, no commitment or compulsion) distribute the profits earned from the Greek bonds purchases to the national central banks of the countries contributing to the bailout.

Currently, the ECB holds some €219.5 billion worth of sovereign bonds (primarily those of PIIGS states) that it has began accumulating since May 2010.

The greatest significance of today's swap is not, however, in the fact that the ECB is likely to make a tidy profit from its operations designed to help Greece. No, the real significance is that in one step, the ECB has completely re-shaped the seniority structure of sovereign bonds issued by all of the euro area governments.

Before the swap, the seniority of bonds was established under the bonds terms and conditions alone, implying equal treatment of all bondholders, with any variation in sovereign bonds security arising from any potential (and highly costly and uncertain) court actions by investors against the sovereigns. Now, the structure has ECB as the holder of the Super Senior bonds with ECB seniority imposed over and above all other bondholders.

In addition, by not bringing into the swap National Central Banks, the ECB threw open the possibility of another sub-tier of seniority emerging over time. In the case of imposition of Collective Action Clauses by Greece or any other sovereign, such clauses will automatically imply non-zero probability of a loss on bonds held by the NCBs. Arguably, they too might follow the ECB line and demand, collectively or separately (as Germany, the Netherlands and Finland are currently already doing) that their holdings of bonds should also be exempt from such a clause. This means that ECB swap opens up a possibility of a new tier of security forming - the tier subordinated to Super-Senior ECB holdings. This can take a form of a Senior tier or Senior Secured tier (if collateral or other security arrangements are put in place, e.g. some sort of an escrow account etc).

The unknown at this stage is the issue of seniority of non-euro area sovereigns holding euro area government bonds. In particular - will China and Japan, the US and Australia etc demand some sort of Senior or even Super-Senior seniority now that the ECB has elevated itself to the level of IMF?

This means that any private investor in Government bonds (note, these are themselves senior to special Government-issued bonds, such as postal certificates, domestic savings bonds etc) is now left a holder of the Junior or Subordinated bonds, despite the fact that on the 'box' the bonds are identical to those held by the ECB, NCBs, Foreign Governments, etc.

The entire market for euro area bonds is now wholly mispriced when risk-return relationships are concerned. Just like that, in a blink of an eye, the European system destroyed legal and financial order and undermined private property rights.


Note: The above arguments are taken from the simple investment risk perspective. Legal perspective is yet to be defined and I welcome any comments on this and/or links to it.

9/2/2012: Few bothers

Today's mid-day CDS spreads (courtesy of CMA):

This should bother few sovereigns:

 and few banks:

And is likely linked to Greek bailout costs falling on: France, Netherlands, and Finland while doing nothing good to over-indebted Belgium and Italy and leading to a slowdown in Norway and Denmark... while taking a bite out of the balancesheets of few big banks. And that comes on top of markets already expecting the fallout from the Greek deal...

26/07/2011: Greek deal will increase Greek debt

Eurointelligence.com today reports that (emphasis is mine):

"Hugo Dixon, at Reuters Breakingviews, did the math on the Greek package, and concludes that the calculation by the European Council and the IIF regarding the projected rate of debt reduction is wrong. He said that Nicolas Sarkozy’s calculation of a 24 percentage point fall in the Greek debt-to-GDP ratio ignores the effect of credit enhancement, which is going to be massive.

Once you include the efforts Greece has to make to secure the rollover deal, the debt-to-GDP ratio rise by 14% to 179% of GDP.

As part of the deal with the IIF, Greece will need to secure some of the rolled over bonds with zero coupon bonds. The four options have different implications for the extent of the credit enhancement. But on the IIF’s own assumptions, the costs of the exercise would be €42bn for Greece to finance credit enhancements for the €135bn of bonds in the IIF’s scheme."

You can read the entire proposal by IIF here. And, by the way - I run through their proposal figures. The massive savings for Greece stated in this are referencing the future payouts that are being saved assuming Greece were to pay full set of coupon payments and principal on its bonds over their history. This is slightly misleading, as the markets have been pricing significant (40%+) discounts on much of Greek bonds for over 1 year now.

Aside from that, the IIF calculations assume 9% discount rate through 2030. This is a strange assumption, given that the deal replaces / writes down bonds with an average coupon yield of ca 4.5% and Greece can borrow from EFSF/EFSM at ca 5% effective rate.

Adjusting for these, my 'back of the envelope' calculations suggest that the actual value of the Greek programme is closer to €26-32 billion instead of €37 billion when it comes to net private sector contribution.

In addition, rollovers to longer maturity, in my opinion, are reducing peak debt levels, but extend payments burden over time, implying that adverse impact of debt on growth and economic performance in Greece are simply extended into the future. In other words, extended maturities do not do much to improve Greek situation. They can be effective if the Greek debt spike were a 'one-off' event. But since debt overhang in Greece is structural (see chart below - showing Greek debt becoming a structural problem around 1993) and underpinned by long term (endemic since at least 1987) current account deficits, extending maturity of debt simply increases life-time cycle of debt overhang.

In summary, there is no substitute to a full default by Greece. The latest 'deal' simply, potentially, pushes this default into 2016-2020 period, and that with optimistic forecasts for growth at hand.

Another can meets the EU boot, and... fails to roll far down the proverbial road.