Fisher Investments Editorial Staff
Market Risks, Politics, Deficits

Huddling Up on Greece

By, 07/25/2011

Story Highlights:

  • A European Council summit produced results on Thursday, with a new plan for aiding Greece.
  • The plan consists of a new loan, voluntary private sector participation in reducing Greece’s debt load and creation of a secondary bond market firewall for peripheral nations.
  • This plan isn’t a European cure-all, but it is a positive step toward a more permanent fix.

News broke Thursday and Friday of preliminary deals in two highly publicized debates over billions in cash between sides that, in each, are incented to reach some form of agreement. Don’t worry, we’re not referring to the US debt ceiling debate—US politicians are still bickering.

The first debate was between the National Football League’s players and owners and was partly resolved Thursday, when owners agreed to a new collective bargaining agreement. Players have yet to approve the deal, so some uncertainty remains. But it is a step toward a season—seemingly a plus for fans.

On a more serious financial note, a European Council summit ended with a new Greek bailout agreement and eurozone stability proposal. Like the NFL’s agreement, this isn’t a fully done deal—details could still be in flux to an extent (heaven knows eurozone leaders have shown the ability to flip-flop since Greece first popped into headlines over a year ago).

As of now, the new agreement will provide Greece with a restructured loan from the IMF, EU and ECB through 2014 valued at roughly €109 billion. Additionally, Greece will receive a reduction in its debt load—through voluntary private-sector participation building off the French proposal we discussed on June 28 here. Under this new proposal, voluntary private-sector involvement (namely, banks) will cause a brief selective default on Greece’s part while bondholders select from one of the four options below for their Greek debt:

  1. Roll over maturing bonds into new 30-year debt.
  2. Exchange existing debt for new 30-year bonds at par, with interest rates starting at 4%. These rates will rise in 0.5% increments over the first 10 years to 5.5%.
  3. Take a 20% upfront haircut (reduction in principal) and exchange existing bonds for 15-year notes yielding 5.9%.
  4. Take a 20% upfront haircut and exchange the debt for 30-year bonds yielding 6.8%.

The newly issued Greek debt would be collateralized by European bonds funded by a portion of rollover and exchange receipts.

Thus far, the plan has been fairly well received by both markets and bondholders—in fact, nearly 90% of banks holding Greek debt are expected to participate to varying degrees. It’s estimated this voluntary private-sector participation will lighten Greece’s debt load by €54 billion through mid-2014. At the same time, bondholders will take an estimated 21% average haircut on existing Greek holdings.

Bondholder haircuts have been a sticking point for negotiations in the recent past, with ECB President Jean-Claude Trichet frequently voicing his opposition. However, that changed with Thursday’s summit—Trichet changed his mind based on an EU guarantee to cover any ECB losses up to €35 billion. Thus, the ECB hurdle has been cleared.

Beyond Greece, European leaders also granted the EFSF the authority to purchase European sovereign debt on the secondary market (in addition to lending to troubled banks). The goal here? Curb potential problems in other peripheral European nations by quelling rising rates on sovereign debt. French President Nicolas Sarkozy called it the creation of a “European Monetary Fund.”

All in all, the deal represents a significant step forward for Europe in its continuing effort to resolve ongoing sovereign debt issues. But it isn’t an immediate cure-all. As German Chancellor Angela Merkel said earlier last week, there isn’t a “silver bullet” to immediately end all of Europe’s ills. (If there were, one would think it would already have been fired.) With that said, the arrangement positively reduces uncertainty and somewhat improves Greece’s future outlook. But European leaders still need to follow through on the plan—and importantly, not all of Greece’s issues (or Portugal’s) are purely debt-related. There is the further (and complicated) issue of the boosting Greek and Portuguese competitiveness—which will take a great deal of political willingness (and a lot less socialism) to accomplish. What European leaders have done successfully is buy more time, ease the debt burden for the eurozone’s most troubled member and set the table for further reforms ahead.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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