Monday, April 12, 2010

Greece Is Saved - For Now.

(h/t Peter Boone and Simon Johnson, The Baseline Scenario)

"The Europeans announced Sunday they would provide
thirty billion Euros of assistance to Greece, amid informed
rumors that the IMF would provide another 10- 15 billion.

" With 40-45 billion Euros in the bag - more than the market
was expecting - the Greeks have time to make changes.

" The Greek government, helped by the market threat of
a near-term collapse, appear to have strong-armed the
other Eurozone countries without making efforts to
change seriously their (Greek) fiscal policy. This is
good for near-term calm, but does not solve any of
the problems now inherent in the eurozone.

" Often, assistance packages of this nature just help
"the smart money" to get out ahead of a default.
This could be the case here; 40-45 billion total Euros
could last roughly one year. Both Russia and Argentina
got large packages in the late 1990's but never regained
access to private markets, so eventually everything
fell apart.

" Sunday's package should make it possible for Greece
to borrow short-term but it takes courage to lend for
5 to 10 years to the Greeks unless there is much more
fundamental change.

" There are two key things to watch for:

" 1) Is the global recovery so strong that Greece's economy
picks up fast and their budget deficit comes down fast?

" 2) Will the IMF and Greeks now come up with a real
austerity program that sharply cuts the deficit so that
a year from now, when the official bailout money could
run out, the market is receptive to Greek debt?

" The danger for private debt holders is clear. Sovereign
loans are invariably treated better in a restructuring
than private debt. So the European aid in some sense
squeezes private debt holders. They will be pleased that
there is no near-term default, but it means their recovery
value has gone down if things get bad again. Greek
long-term yields will probably stay high. The key market
reaction to watch over the next 6-12 months will be
long-term yields, and whether these come down to
levels that imply low risk of default.

" And there is still definite risk of contagion. The
actions of the EU show that they are willing to
intervene when yields get up to 7-8% on long-term
debt and markets close off to a nation.

" And what does this mean for Portugal or Ireland?
People holding Greek debt lost a lot of money in the
last few months. That will not come back soon, as
market will for a long time be wary of buying their
debt - especially as Fitch just took the Greek rating
to BBB minus - i.e. the floor at which the ECB lets
banks borrow against ("repo") government debt.

"The Portuguese, therefore, are not at all out of
the woods. If they do not start making serious
moves towards cutting their deficit, they are
next for a test.

" Surely the Eurozone will bail out Portugal
next - but where would it stop after that?
The stronger Europeans, by coming to Greece's
rescue at this time with little conditionality,
are effectively showing all the weaker nations
that they too can get a package. This will
undoubtedly reduce the incentive for
needed fiscal reforms across the European

" We are still lurching from crisis to crisis
in Europe. "

My take on all of this, as "The economist
watching from the bleachers" :

First, as I predicted in these pages a few
months back, the ECB and the stronger
Euro powers would not let Greece go
down the tubes, and that a "rescue"
would also involve the IMF. That has
now happened.

Second, I do have a slight "bone to
pick" with the composition of the
package. Were The Thinking Nationalist
the governor of the ECB, I would have
preferred a guarantee of funds raised
in the private debt market to outright
direct aid, and would have induced
the IMF to proffer any direct cash
assistance required. With an ECB
guarantee, the coupon rate on new
debt might have been just a bit less
(although not in the sub-market
5.00- 5.125 rate that the ECB is now
contemplating), and with an IMF - blessed
austerity plan in place, confidence in the
market for Greek debt might ultimately
have been restored - especially if the
guarantee had been extended to the most
recent 12 billion Euro debt issue.

No doubt this option was considered -
and probably rejected as inadequate for
the task at hand. But now we have the
worst of both worlds - the current holders
of Greek debt will have to take a substantial
haircut owing to restructuring priorities (if
it comes to that), precious little will have been done
to restore real confidence in the Greek debt market,
and moral hazard will now have been broadcast
to the rest of the Eurozone as the plan du jour.

The line for aid will now form to the right -
please keep it orderly, folks.

And finally, 45 billion Euros will only get
Greece halfway there - estimates of Greek
needs over the next 2-3 years run from
80 to 100 billion Euros. But, we'll see.

Greece has bought precious time for now -
whether any good comes of it is still an
open question.

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