The Greek bail-out plan is bad for Greece because after execution of that plan it will have a higher debt after 30 years and a higher interest rate after 2016. It is also bad for Europe because the financial support to Greece from the “surplus” countries will go directly to the banks.
The existing junk assets from the subprime crisis together with the PIIGS-bonds, mean that every payment to banks will be retained to improve their capital base. This money will not be brought into circulation for the real economy and therefore has no positive economic effect on the diminishing investments and falling demand that cause the current recession.
Meanwhile a “haircut” is discussed but in reality the banks are prepared to accept less profit. This is not a loss as the word “haircut” would imply. It is unfortunate that this is not widely known, while this has already been published on August 5, last, by Bloomberg (Europe’s Plan Won’t Cut Greek Debt: Allen, Eichengreen and Evans). More problematic is that our politicians don’t know or understand this. But it’s not that complicated.
Based on the Bloomberg article, it becomes clear that the so-called haircut is a consequence of an exchange of current bonds with new bonds at a lower nominal value. To simplify things, let us take the example of one Greek bond with a term of 30 years and a nominal value of EUR 100. Currently interest amounts to 5,02%. (Some basic terminology is explained at the end).
This bond will be exchanged for a bond with a nominal value of EUR 80, the same term, but a variable interest. The first five years this interest will be 6%, after that for another five years 6.5% and for the remaining 20 years 6.8%.
After the 30 year term the original bond would lead to 30 interest payments of EUR 5,02 and EUR 100 at maturity, for a total of EUR 250,60. With the new bond the interest payments would be 5 times EUR 4,80, plus 5 times EUR 5,20, plus 20 times EUR 5,44. Together with the EUR 80 at maturity, this results in a total of EUR 238,80.
Ergo after the first five years the interest payments are higher than under the present situation, while after 30 years the cumulative debt relief would be EUR 11,80. The Net Present Value therefore drops by 1,74% and not the 21% the banks mention. Also, the 50% “loss” mentioned by Juncker on 22 October last, is still not a loss, but roughly halfs the profit.
Part of the deal are three other financial instruments that lead to an eventual debt relief for Greece of EUR 9.15 billion on a total debt by the end of 2011 of EUR 346 billion (IIF estimate). A reasonable plan, it seems, but it is not the whole story.
In order to convince bond holders to take part in the above bond exchange, the banks require Greece to provide collateral in the form of zero-coupon bonds with a term of 30 years. Considering Greece has no money to do so, it will have to borrow money from the EFSF to finance the zero-coupon bonds. Interest will have to be paid over that loan as well: 4% the first five years, 4.5% the next five years and 5% for the remainder of the term.
This debt will increase their total debt by EUR 42 billion while the interest payments will increase as well. The conclusion is that this deal does not lead to a debt restructuring. The restructuring is aimed at the ratio between debt and GDP and has to be improved, according to this plan, via far-reaching privatisation, increased taxes and austerity measures by Greece.
Meanwhile the calculation by the Institute for International Finance (the banking lobby) makes several assumptions about the Greek economy that in themselves are already very questionable. More serious than that is that no analysis whatsoever is made to assess the likely consequences of the proposed bail-out plan.
It is generally known that an economy can only growq through rising demand or increased investments. The chosen direction, however, will lead to a drop in demand due to austerity measures, increased unemployment, higher taxes and lower wages. The money made available through the austerity measures and privatisation is not interested, but is directly used to pay debt. A debt that does not become smaller despite this.
The problem for Greece will not be solved but postponed for five years, only to return worse. If the Greek bail-out is not a bail-out for Greece, we should question what is going on. The eurozone continues to be exposed to the same systemic risks; collectively there is no improvement.
Aside from Greece and the eurozone partners, only the banks take part in the negotiations. It is logical to assume that bail-out is therefore for the banks. Why? Because the eurozone partners are fearful that a collapse of the bond markets for the PIIGS-countries will in all likelihood lead to the collapse of the eurozone.
On October 15, last, the IIF “warned” that if the eurozone does not keep its part of the deal, many bondholders (read: banks) might have to sell bonds of other countries as well, which would lead to the likely collapse of the eurozone. Considering the above, that “warning” leaves a rather bitter taste.
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All calculations were provided by F. Schrijvers and can be found here.
Basic terminology:
Bond - is basically a loan agreement where the party issuing the bond, borrows money from the holder of the bond and generally owes him interest as well as the nominal value of the loan at the end of the loan term. No installments are paid under a bond, so the money owed stays the same until the end of the agreement.
Nominal, par or face value – the sum that will be paid back on the date the bond matures (the end of the agreement).
Maturity (date) – the day the bond agreement ends.
Coupon - another name for interest.
Zero-coupon bond – a bond where the borrower pays no interest. In this case the nominal value will be higher than what the borrower receives as a loan. For instance, the borrower issues a bond for 100 EUR to be paid in 10 years. In that case, the lender (bond holder) will pay, for instance, 60 EUR for the bond. The 40 EUR difference is to make up for the fact that no interest would be paid over the loan but instead the bond holder will receive the full 100 EUR (the nominal value of the bond).
