Letter to Santa,
Dear Santa, I am the Greek
government and I know that I have not been a very good child lately. I was
placed on the naughty step many times this year for not behaving properly.
Despite my parent’s good will and encouragement I did not manage to reduce significantly
my addiction to the soviet style state, I did not brake relations with my good
friends the unions, or increase my rather poor grades in housekeeping. I also
failed to share some of my prized toys and possessions with other kids. I know,
“If you do not share (sell) you do not play” but I really can’t. I realised
that my finance minister behaved rather impolitely to your representative elves,
but he has now learnt who is filling his dog bowl with goodies and realigned
his allegiance accordingly. He realised
that our benevolent parents assign the top dog position. Although I cannot
claim to have repented in full, I did change the Prime Minister as instructed
by our well-meaning parents. I reluctantly formed a unity government consisting
of some right wing xenophobic fascists, hysterical nationalists and utopian
socialists. Although this is not the ideal, it is the absolute best, the crème
de la crème, of the Greek political system. So, please, please, please can I
have my PSI for Christmas? I promise to be good going forward.
Signed
Greek Government
PSI
The original PSI back in July, asked for a Net Present Value loss of 21%
assuming an exit yield of 9% for the Greek bonds. That was a truly bad solution
for Greece as we quickly pointed out in our letter. It did not alter the
dynamics or the sustainability of the Greek debt at all. In fact the whole idea
of the PSI is bad. It is for this reason that the decision was taken last month
of abandoning the PSI going forward. For Greece though, they did something
different. They not only kept it, but also managed to make the PSI really bad
both for Greece and the bondholders. Let's see how they managed this feat.
PSI is bad for bondholders who have already taken the pain
Restructuring one’s debt is a high art. You haircut too little and there
is no benefit to the issuer. Haircut too much and bondholders have no incentive
to accept you offer. The original 21% NPV loss would not have made any
significant improvement to the sustainability of the Greek debt. It was
therefore good that it was abandoned. The current one however, swung the other
way. By insisting on a nominal haircut of 50% and at the same time insisting
rather perplexingly to be voluntary they completely altered the incentives.
Most but not all the European banks have already taken the hit and
marked their GGB’s very close to the market value (25-50). This means that they
have already taken the pain. It is a sunk cost. Example:
GGB 4.6%, May 2013 is trading around 30%. Assume further that a German
bank has marked it at 40%. The bank is now given a voluntary choice of entering
into PSI with 50% nominal haircut and further NPV haircut of unknown
proportions. This is because the T’s (Terms) and C’s (Conditions) of the new
bonds are not known. Assuming another 20% NPV (20% of the 50%) loss it would
bring the new Greek bond at 40%. What happens though if the trader decides to
hold out. He risks being coercively restructured, in which case he may get
recovery between 30-40% or he may get his full money back (100%). Any trader
will tell you that the risk return profile is highly skewed towards free riding
(Holding out) like the ECB. You can read further on the joys
and thrills of free riding.
Thus anyone who has either bought his GGB near the current market value
or has taken the cost and has marked them close to market would be better off
holding out, in brotherhood with the ECB and the official sector.
Furthermore, giving the already burned bondholders again Greek risk
(bonds) for another 30Y (with or without principal guarantees) would be a
nightmare for all of them (risk managers, traders, accountants and Basle
regulatory capital charges)
PSI is bad for Greece. Punishing Bondholder is not in the interests
of Greece
Greece may be asking Santa for a PSI present, but as they say, “be careful what you wish for”. To be
honest, this is not what Greece wants, but what Merkozy ordered Greece to want.
Greece as far as we can tell, never had a policy on how to manage its own
liabilities or any inclination to form a coherent strategy to tackle the
problem. They Greek government combined happily, ignorance incompetence, and
incapacity.
Germany wanted the PSI as a means to punish the private bondholders. In
fact the market through the price action has punished them far more than the
insane PSI. Punishing the bondholders however, is NOT in the interests of Greece. Greece should only care
about the exit yield, the exit rating and the sustainability of its cashflow.
Exit Yield: This is
the yield at which the Greek bonds would be trading after the
restructuring.
Exit rating: This is the rating that agencies would assign after
the restructuring has taken place
Sustainability: Would
Greece be able to pay for herself after the restructuring?
Unfortunately, the PSI in its current form fails to deliver all three.
This is because the bondholders demand very high coupons that negate the
sustainability, exit yield and consequently the rating. In fact, Greece
currently still runs primary deficits with and economy on a free fall. It is
highly improbable that Greece would be able to pay any coupons in the next few
years without further borrowing. Add to this the contentious issue of the new
bond’s Jurisdiction. Bondholders demand English law.
English Law Jurisdiction.
Germans demand the protection of the English!!!
What is the probability that the new Greek bonds given after the PSI,
would need to be restructured again? Any unbiased observer would say more or
less 100%. Which is why German bondholders demand English justice. One cannot
help but giggle at this. Germany, and in fact the rest of the Eurozone, accepts
that the English law and courts have far more weight, knowledge and experience
and offer more protection than their own justice systems.
Only Alternative is to Buyback
There is however, and alternative
that is attractive to both Bondholders and Greece. That of a voluntary
offer to buy the bonds backs at 35%. I say voluntary to keep with the PSI demands.
After all, only bondholders that are amenable to European political pressure
would participate in the PSI. Instead of giving them new Greek risk with
English law, just pay them 35% and be done with it. What are the merits of this
alternative?
·
Debt is reduced to around 120% day one. This is
how:
o
ECB gets 70% on 50billion. Pay 35billion
o
From the rest (160billion) 15% stay out: Pay
24billion
o
Buyback at 35% of 136billion; Pay 47billion
Thus with 106
billion Greece can retire/service 205 billion. This would bring the total debt
day one, at around 260billion or around 120% of GDP.
·
Greece would not have to pay anything for the
next 10Y as these loans are subject to the Grace period.
·
Greece would not have to accept foreign
jurisdiction in its bonds
·
Bondholders get cash and do not have to deal
with the risk management Greek bonds again.
·
Bondholders have been punished by the market and
not by some European decree.
·
Greece cleans up their bonds. Now it can be free
to introduce new ones, with CAC’s
·
Greece should be upgraded as the old debt is
destroyed and the sustainability of the Greek finances is improved by having
the 10Y grace period.
·
Bondholders would not suffer any further losses
or have their risk management departments ask for more provisions.
·
It would not be a Credit event! Greece may be
placed under Selective Default for as long as the offer to voluntarily buy back
is open. This is exactly what is going to happen once Greece makes a formal PSI
offer.
Of course one
may ask, where would Greece find the money to do this buyback. The buyback
assumes that either the EFSF or the new ESM mechanism would provide the loans
after the sustainability study.
Conclusion
The PSI was always a bad solution. It was one more mess introduced by
politicians. The market has given its answer to both the PSI and is clearly
pointing to the only real alternative for both Greece and bondholders. Buyback
the bonds and stop the charade of the so-called negotiations.
