The Eurozone after the November Eurogroup ‘Greek Deal’: On the current state of play

On November 27^th, 2012, the Eurogroup (comprising the Eurozone’s finance ministers) reached a decision on Greece. Its essence is a guarantee that Greece will remain in the Eurozone (and therefore off the Northern European agenda) for another ten to twelve months; at the very least until the German federal political cycle has seen through the election of a new Bundestag. The repercussions of this short-sighted agreement are grave not only for Greece but for the Eurozone, and indeed the European Union, more broadly.

To accomplish the task of taking Greece off the minds of markets and Northern European electorates for this space of time, Eurogroup ministers came to an agreement with the IMF on how to patch up their conflicting agendas on Greece by means of a joint communiqué according to which Greece’s de-railed Bailout Mk2 is, supposedly, back on track. The basis of their agreement is twofold:

• The IMF will pretend it believes Europe’s claims to have rendered Greece’s public debt viable without an OSI (i.e. a haircut in the loans provided to Greece by the troika, aka its European partners), while
• Europe will pretend that it can do this without an OSI.[1]

The idea here is that, yet again, the Eurogroup-ECB-IMF alliance is not ready, politically, to reveal the truth to its various constituencies.

• The German and Dutch governments (not to mention the Finnish) feel it is impossible to tell their Parliaments, and voters, the terrible truth that some of the money they have put up as part of Bailout Mk1 & Mk2 will not be retrieved.
• The IMF cannot admit that it allowed Europe to involve it in a country program that does not fulfill the debt-viability conditions that any IMF program ought to.
• The Greek government has invested its survival on misleading its constituency into believing that the tailspin of the Greek macro economy can be arrested under the current arrangements.
• And, finally, the ECB is struggling to maintain the illusion that it can remain faithful to its no bailout clause vis-à-vis governments, especially in view of the great challenge awaiting in relation to Spain and Italy.

This holly alliance of subterfuge and double-speak raises a pressing question: What does this new ‘Greek Deal’ mean for the Eurozone in the medium to long run? Before discussing this question, a quick look at the latest ‘Greek Deal’ may be helpful.

The latest ‘Greek Deal’: From OSI to PSI Mk2

Last year’s Greece’s Bailout Mk2 was predicated upon the fantasy that Greek debt would fall, as a percentage of GDP, to 120% by 2020. The specific number, of 120%, was chosen by the IMF as the level that allowed it to remain part of the Greek ‘rescue’ effort (nb. since, unlike the Europeans, the IMF is charter-bound not to provide loans to a country with a runway debt to GDP ratio). What gave ‘credence’ to this target (in the eyes of the unschooled and uninitiated into the laws governing imploding macro-economies) was the substantial haircut that was part and parcel of Bailout Mk2 – the so-called PSI, which imposed ‘voluntarily’ on private bond holders a write down of 54% of Greek government bonds’ face value (on the basis of a swap with longer maturity bonds) which, in present value terms, translated to a 75% haircut. The gist of Bailout Mk2 was: Greece would be back on track on the basis of further austerity, a new 130 billion euro loan for Greece, a 100 billion private sector haircut, and a privatisation drive that would, supposedly, raise 50 billion euros.

As many of us were predicting at the time, screaming our predictions from the rooftops, it took only a few months for the predictions of Bailout Mk2 to reveal themselves as pure fantasy. Less than a year later, Europe had to confess that Greece’s debt to GDP ratio was edging toward 200%. Clearly, the IMF’s Ms Christine Lagarde could no longer pretend that the IMF was faithful to its own charter in remaining part of the Greek ‘program’. And since the German government needs the IMF to remain on board, so as to convince the German conservative side of politics that its ‘Greek strategy’ remains intact, some new ‘deal’ on Greece was necessary that would allow for a re-freshed claim that Greek debt can be pushed down to around 120% by 2020.

To procure this magic number, the powers-that-be had, somehow, to argue that Greece’s GDP will rise by about 50 billion while its debt will fall by 40 billion (nb. for if this were to happen, by 2020, Greece’s debt to GDP ratio would be back to just over 120%, thus keeping the IMF’s board, if not happy at least, pliant). This is precisely what they announced on 27^th November: a boost in GDP by 50 billion and a concomitant reduction in public debt by 40 billion.

The first observation regarding these two numbers is the audacity of the first one. At a time when Greek GDP is shrinking inexorably, and with new austerity measures that amount to fiscal waterboarding of a national economy (new austerity measures of 12 billion euros for 2013 alone), the troika of Greece’s lenders had no compunction in predicting that, somehow, the Greek economy would miraculously achieve a growth rate of, on average, more than 4% annually for at least eight years. And all this with a broken banking sector, no serious investment by the European Investment Bank and, to boot, within a Eurozone that is caught firmly in the clasps of a double-dip recession!

Setting aside this preposterous ‘plan’, let us now turn to the Eurogroup’s other ‘number’: the planned reduction of Greek public debt of 40 billion. How do they intend to effect this? By three means.

First, by cutting 1% off the interest rate Greece pays for the loans given in the context of Bailout Mk1. How much is this going to shave off Greece’s mountain of public debt? Two billion, is the answer. OK, 2 billion gone, 38 to go.

Secondly, by postponing by 15 years the repayment of capital and 10 years the repayment of interest on Bailout Mk2 loans. How much does this reduce Greece’s debt by? If this is a mere re-scheduling, as it seems to be, it does nothing to reduce debt per se. What it does do is to lighten the repayments that the Greek government will have to be making for the period of grace granted. (If the interest rate is, later, pushed below 2% then there will be an element of debt relief, but nothing that makes a substantial difference to the 2020 target.)

Thirdly, by returning to the Greek government the profits made by the ECB on Greek government bonds that the ECB purchased, at a discount, between 2010 and 2011 as part of the failed SMP program (when Mr Trichet’s ECB purchased second hand Greek, Irish and Portuguese bonds in an ill-fated attempt to prevent these states from going under). How much will Greece get from that? Around 7 billion is the answer.

So, by means of an interest rate reduction and an ECB-profit return, 9 billion euros will be shaved off Greece’s debt. This leaves us with 31 to go in order to reach the target of 40 billion announced by the recent Eurogroup decision. Where will these come from? Answer: By means of a debt buyback. Greece will be lent more money by the EFSF with which to buy back its own post-PSI bonds and tear them up (or ‘retire’ them, in the trade’s own language). At the time just before the Eurogroup met, Greek bonds were trading at a price of 35% of their face value. Assuming that Greece was given 16.7 billion euros from the ESFS (in new loans), it could buy back (at that price, 35% of face value) 47.7 billion of its own bonds, in order to retire them. Hey presto, the debt reduction of 31 billion (47.7-16.7) that the Eurogroup announced would be a reality!

Alas, if Greece is given enough cash to buy a significant part of its distressed bonds in the open markets, the increase in demand for these bonds will push up their price to an extent that the debt buy-back will be pointless. Already, the mere rumour of this debt-buyback pushed Greek bond prices well about the 35% level. For this reason, the Eurogroup decided to fix the debt buyback price at the 35% level that was the going rate on the preceding Friday. In other words, the proposed debt buyback will not take place at a free-floating price but at a price set by the Eurogroup which was designed to ignore the increase in demand caused by the… debt buyback itself. To put it differently, the Greek government must now convince bond holders to sell their Greek government bonds to back to the Greek government at prices which are now much lower than those determined by demand and supply (i.e. by ignoring the effect on demand that the EFSF loan to the Greek government has effected).

To gain a perspective on the Greek government’s problem, in convincing the private sector to sell 41.7 billion worth of bonds back to it, at 35% of face value, it is worth nothing that the total value of bonds in the hands of the private sector, globally, is 61.8 billion. Of that, 15.2 billion is held by Greek banks, 8.6 by Greek pension funds and then rest (38 billion) by non-Greek investors, mainly hedge funds. So, the success of the debt buyback program will depend on non-Greek investors. Assuming that Greek banks and pension funds can be made ‘an offer that they cannot refuse’ by the Greek Finance Ministry (nb. already the Greek Finance Minister has told them that it is their… ‘patriotic’ duty to cough up their bonds at the offered price), the Greek government will be short by 23.9 billion (nb. it needs to buy back 47.7 billion, minus the 23.8 held by Greek banks and pension funds, equals 23.9 billion). Will foreign institutions, and hedge funds in particular, ‘play ball’? Or will they hold out for a higher price (perhaps for a 100% redemption even)?

With these thoughts in mind, it is clear that the latest Eurogroup decision will go down in history as the precursor to PSI Mk2. The reader may recall that this Eurogroup summit was supposed to, at the IMF’s behest, usher in the long awaited OSI. But resistance from Germany led to the debt buyback idea which is no more than a disguised new PSI primarily for Greek banks and pension funds. Not only will we fail to achieve the target of 40 billion debt write off but, at once, the already bankrupt Greek banking and pension system be given another major push into the mire of irretrievable bankruptcy; the very same banking (and pension) system which is supposed to provide the financing and backing for a rebound of Greek GDP to the tune of 4% per annum…

What does this all mean for Greece, for the Eurozone, for Europe more broadly?

It is clear that the Eurogroup cannot be serious about either its Greek debt or its Greek GDP targets. The November 2012 decision was merely a pretext for releasing withheld loan tranches to Greece so as to buy another year or so for Europe to patch up, in similar fashion, its crisis elsewhere – in Italy and Spain in particular. Meanwhile Greece has been condemned to another year of misery, failed targets, depression etc.

The Eurogroup’s underlying ‘logic’ is that, as long as the Samaras government plays well its ‘model prisoner’ role, Greece will be given its OSI after the federal election in Germany is over, in September 2013. Many commentators, even those critical of Europe’s dithering, welcome the implicit acceptance that an OSI is inevitable. I think they are wrong. Take for instance last year’s PSI. What did it prove? It proved that a haircut can be meaningless if badly delayed. While it is true that a haircut of privately held debt in 2010 would have been helpful, Europe’s insistence that there would be no such haircut (and its desperate attempts to fill the gap by huge loans and austerity) ensured that, when the haircut came (with the PSI), it was too little too late. Similarly with the impending OSI: when it comes evenutally, after the awful delay effected by the latest Eurogroup’s shoddy ‘Greek Deal’, it too will prove too little too late and too toxic not only for Greece but for Europe as a whole. In short, delaying the delivery of the inevitable medicine turns it into poison.

So, what will come of Greece, given the latest Eurogroup ‘decision’? It is my fear, and belief, that the country is becoming a version of Kosovo – a protectorate in which the euro remains the currency, sovereignty is minimal, the population is ruled over by a glorified kleptocracy with strong links to Berlin and, last but not least, a permanent migratory flow is established that sees the young and the skilled move to northern Europe and beyond.

Turning briefly to the significance of the latest ‘Greek Deal’ for the Eurozone as a whole, the omens are particularly troubling for Spain and Italy. First, there is the small matter of the inbuilt domino effect. The reader is reminded that the reduction in Greece’s interest rates (which will be enhanced in the not too distant future further, as the Greek state grows increasingly unable to repay its partners’ loans), will translate into losses by the Spanish and Italian governments (since other troika ‘program’ countries, i.e. Ireland and Portugal, have been spared). The fact that the markets’ expectation of some OMT assistance for Italy and Spain are keeping their bonds’ yields low, for the time being, does not alter the fact that the vicious contagion dynamic is gathering strength.

Beyond this ‘small’ matter, Rome, Madrid and, indeed, Paris must now reckon with a Eurogroup decision that demonstrates how bogus all talk of a Growth Pact really has been (since President Hollande raised it as an issue a few months ago). The fact that the Eurozone’s finance ministers declared, without the slightest hesitation, that substantial growth will come to depression-hit Greece without an iota of a smidgeon of a hint of fresh public investment reveals that Europe is truly blind to what it will take to deal with the recession it faces in aggregate and with the various depressions in its Periphery.

Last but not least, the readiness to sink Greece’s already bankrupt banks further into bankruptcy (by imposing upon them surreptitiously PSI Mk2), rather than implementing the June 2012 Agenda for decoupling the banking crisis from the sovereign debt crisis, is yet another sign that the Eurozone remains on the road to ruin. And, as long as this is the case, the European Union will be increasingly buffeted by the centrifugal forces (especially those emanating from London) that may well cause its evolution into, at best, some form of NAFTA-like quasi-free trade zone.