“Investors cheered, politicians beamed and the markets rallied at the end of last week, when European leaders agreed to a new €109bn bail-out for Greece,” says Walter Molano of BCP Securities. After much haggling, leaders agreed yet more measures to help Greece and other struggling governments with their financing and solvency crises.
This time, the outcome “cannot be dismissed as just another last-minute fix”, says the FT. It shows that politicians are recognising reality, offering cuts in Greece’s debt burden, through a complex arrangement of bond rollovers, debt exchanges and guarantees, as well as lower interest rates for Ireland and Portugal. The European financial stability fund will now be able to buy back bonds and assist banks, hopefully meaning it can head off further contagion. Finally, there was at least a perfunctory nod to the need to stimulate growth, although it lacked any detail.
Still, the plans do not fully address the fundamental economic and fiscal problems, says Capital Economics. Leaving aside questions about whether they are workable – especially when it comes to private-sector participation in restructuring Greece’s debt – the proposed future debt relief amounts to 20% of total liabilities in today’s terms. That’s still way below what most analysts think is needed. Indeed, ultimately “debt holders are likely to face a 90% haircut”, says Sean Eganof Egan-Jones Ratings in Barron’s. For Ireland and Portugal, haircuts will also be much harsher than at the levels hinted at recently. Unless trends reverse, Spain, Italy and Belgium will follow. “The resolution of this sovereign debt crisis will remake the face of Europe over the next few years. This is going to be one truly big story – on the scale of the instability of Germany’s Weimar Republic after World War I.”
That will create turmoil for Europe’s banks – but at least they do not yet have to worry about losses from credit default swaps (in effect insurance policies) on Greek debt. Ratings agencies are calling the haircuts a selective default. But the International Swaps and Derivatives Association (ISDA) has ruled it will not trigger payouts because acceptance by bondholders is voluntary. That decision might reflect rumours that one institution has a $20bn net exposure, says Molano. ISDA’s decision may prevent its collapse but will also “force investors to reconsider the future” of credit default swaps.