Eurozone again whipped by Greek winds

Athens general views

The details of Private Sector Participation (PSI) in the haircut of the Greek debt is presently the critical issue, on which will be judged not only the prospects of Athens regaining sometime in 2015 the possibility of self-financing its debts, but the outcome of negotiations over the PSI will also define the overall abilities of Eurozone to regain a long term sustainable financial equilibrium. In March 2012 negotiations over the Greek PSI were abruptly stopped when the negotiators of the International Institute of Finance (IIF, represents the majority of the private lenders to Athens) left Athens to return to New York, complaining that the EU representatives are retracting from the principles set at the EU leaders’ Council of 28 October 2011.

At this point it must be clarified that there are three parties in those negotiations: Greece, represented by its minister of Finance, the EU-ECB-IMF who are currently financing Athens and the IIF. The basic principles or a PSI is that private lenders to Greece will accept a 50% reduction on the nominal value of the debt paper they hold and receive a mix of 15% in cash and 35% in new bonds guaranteed by the European Financial Stability Facility (EFSF).

The problem however is that after the end of October 2011, a number of hedge funds, most of them being controlled by ‘money sharks’, have been very active in buying Greek debt in the secondary market at prices ranging from 40% to 50% of nominal values. If those ‘investors’ are to be given the terms agreed on 28 October, it will be like rewarding the worst practices of financial profiteering. In any case the all parties’ agreement on the PSI operation has been planned in a way that it must leave Greece in a position to be able to reduce its entire sovereign debt at the level of 120% of the GNP in the year 2020. The 120% of the GNP threshold of indebtedness is considered by the IMF as the upper limit of debt to Gross National Product ratio, permitting to the Fund to continue financing a country.

Negotiating the PSI

Now the idea within the Greek and EU negotiators is to keep the initially agreed haircut percentage at 50%, but to reduce the interest rate on the new bonds to replace the 35% of the nominal value of the old ones, at 3%. On top of that, they also want the private lenders to accept that the new bonds will be of much longer maturities than the ones to be replaced.

In total, on a present value base of evaluation of bonds, the losses from the PSI for the private lenders will exceed the 50% and will reach the 60% or even 70% of nominal values of bonds now held. As a result, the private lenders say that the European negotiators are overshooting the mandate of the EU Council of 28 October 2011. The counter argument, however, is that a large number of Greek bonds are bought after the end of October at reduced prices, and their holders are not justified to ask for extravagant returns within the brief period of a few months.

The hedge funds

In any case the issue of the interest rate and the maturity may be settled soon, especially when it comes to traditional investors in the Greek debt, like pension funds, insurance companies and major banks. The problems arising from a number of late comers to the Greek debt, like some hedge funds. Those ‘money sharks’ insist that they will not participate willingly in the PSI, expecting to make gains from having insured their titles at Credit Default Swap (CDSs) market.

In view of this the European negotiators try to attract as many willing participants in the PSI as possible, offering ‘carrots’ from the interest rate and the maturity fields. If they manage to attract a 70% or more of the private lenders to Greece, then they can apply the Collective Action Clause (CAC) to force the rest of lenders, that is the hedge funds, to forcefully participate in the PSI, without triggering payments of CDSs on their bond holdings.

Present value

Presently those negotiations appear to be in a stalemate, but Greek government representatives have rushed to New York to meet with the people. Those last are expected to return to Athens within this week and sources in Greece say that an agreement may be announced as late as next Monday. If those negotiations fail to produce results Greece will enter uncharted waters and along with Athens the rest of the Eurozone will have a tough time over the next months or years.

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