Busch: The Greek Endgame is Now
For weeks, Greece has been saying that they will run out of euros by mid-October.
On October 14th, Greece has a 2 billion-euro interest/note redemption due.
While it is a major assumption to believe Greece on their finances, we have to take seriously that they won’t have the funds to make the payment. This is why they approved a series of austerity measures to try to meet the criteria set by the Troika of the IMF/EU/ECB to get the next tranche of bailout money.
On Monday and Tuesday of this week, EU finance ministers met and discussed what options were needed to aid Greece, what actions were needed to provide comfort to Finland for their collateral demands and what structures should be used for a Greek default. Next, the Troika was expected to give their approval this week and have the Euro zone ministers/leaders vote to approve the aid tranche on October 13th. Finally on October 17th and 18th, the EU heads of state and government were to meet in Brussels to discuss further action on Greece.
Today, the news flow out of the EU Fin Min meetings is pointing to a default. First, the July 21st agreement for 21% haircuts for Greek private sector bondholders or PSI (private sector involvement) is being reviewed for change. After chairing a meeting of euro finance chiefs in Luxembourg, Luxembourg Prime Minister Jean-Claude Juncker told reporters, “As far as PSI is concerned, we have to take into account that we have experienced changes since the decision we have taken on July 21…These are technical revisions we are discussing.” The changes have been a sharp drop in the value of Greek debt that is currently trading between 45-55% of face value.
Juncker also stated that the October 13th meeting to decide on the next Greek payout was canceled. However, Junker did say he is “nevertheless optimistic when it comes to the issue of the disbursement” by the end of October.” It appears that the decision will coincide with the October 17-18th EU leaders summit. Yet, Greece could miss the October 14th payment if the tranche is delayed until the next week. Today, Greece said that it can wait until November as they will continue to pay salaries and pensions. No word on what will happen with the bond and interest payment.
To me, this demonstrates that the euro ministers are working on a restructuring for Greece that includes much larger haircuts for the private sector and that they don’t want to make a payout until this is settled. Why? If you pay out 8 billion-euros to Greece, then they will in turn make full payments to bond holders. This would be rewarding them for owing the bonds and alleviate any losses. If EU ministers know they are going to force a 50% haircut on bondholders, they would want to wait to delay any bailout payment because 50% of the money would be given to whomever Greece pays before the announcement.
Of course the longer EU ministers delay, the more the markets sell not only Greek debt, but also European core debt, European bank stock and the euro. There is a reason why during the Latin American debt crisis the negotiators met in secret and came to agreements with debt/loan holders over a weekend. They didn’t want a leak generating uncertainty and selling of those countries’ stocks, bonds and currencies.
This is the central problem with what is happening in Europe: it’s taking too long and too many people are aware of what they are doing. It’s elongating the process, driving asset values down and making the negotiating process unmanageable. It’s why foreign leaders are demanding faster action.
The endgame is now for this process. One potential outcome would be for a bifurcated bond structure to be announced whereby bondholders have a choice between a collateralized, fixed rate bond with a haircut and longer maturity and a floating rate bond with a larger haircut and a shorter maturity. Also, EU ministers should announce capital injections to their banks to assist with the capital write-downs that will occur with the default. According to Bloomberg, French banks continue to carry Greek debt at 79% of its face value.
Until the details are known and actual decisions are made, the markets will continue to drop as they anticipate the negative outcomes. The sooner they act, the smaller the losses will be for risky assets. The sooner they act, the sooner the markets will stabilize. After the dust settles, I expect a strong rally (5-10%) in Risk-On trading with bonds sold, US dollar sold and equities purchased.
Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.