The French proposal

Posted by Neil Hume on Jun 28 09:57.

You should all now be familiar with the EU ‘Brady bonds’ plan for Greece.

But what are the pros and cons of this French-led initiative?

Here’s RBS’s Harvinder Sian with his thoughts. We start with the short term positives:

1. The rollover discussion looks like it is getting more advanced and an IIF meeting tonight in Rome should give more colour on how the proposal fits with concurrent discussions in other European countries on how to conduct the rollover.

2. Rolling over debt to 30y is far better than a new 7y bond in terms of buying time for Greece.

3. The credit enhancement has strong echoes of the Brady bond plan. Note that there were many different types of Brady bonds and that linking the 30y bonds to GDP was seen in Argentina which is a negative headline comparison but nonetheless does link payments to the ability to pay. (The absence of GDP linked bonds in the market is linked to data quality but also a stigma attached to a crisis instrument.)

4. It shows some credit risk transfer to core EMU and the hope is that it could be a template for wider debt reform. It remains to be seen whether France can get the guarantee from the EFSF or whether there will be a country-by-country approach.

On point four, Sian says this comment from the EFSF website is notable:

“The Framework Agreement does not contain any maturity limitations for the loans nor for the funding instruments. They will be defined on a case-by-case basis.”

In other words, this statement is consistent with issuing 30-year zero-coupon bonds directly to banks.

But is any of this a game changer? Or is the battered Greek can just being booted even further down the road?

Well there’s a number of things it does not and cannot change, reckons Sian:

1. The Greek government is approaching the limits of its cohesion to push through austerity and so the likely required remedial measures when the austerity plan gets behind target again will bring back the current political crisis, only with more tension.

2. The private sector rollover discussion is all about limiting the public sector exposure to Greece and shows the less cohesive solidarity of the region.

3. That puts the Brady bond type of solution in context – namely that some public exposure is still apparent – but the public exposure is still far lower than the instance of the EU/IMF covering all maturing Greek debt. So, it is a classic EMU good news story in that it exists only in the context of a problem that Europe has created for itself in the first place. This will be no victory in the EMU crisis but is a reminder of the conflicting political aims of Nordic EMU versus the wider interests of the region.

4. Greece’s debt load will remain too high. This is a key point: namely that the LatAm Brady bond solution was accompanied with debt restructurings. Europe still seems far from managing the high debt problems with such a holistic approach.

That is indeed the key point. The original Brady Bonds were accompanied by debt restructurings. And the Greek Brady Bonds won’t.

That said, the situation is undoubtedly better than it was at end of last week, says Sian.

Net/net, the short term headline news is positive from where markets were at the end of last week as European politics & Greece looked in disarray, but even if a portion of Greek debt is rolled to 30y across Europe and there is a credit enhancement; the fact remains that the underlying political (EU & Greek) and the high debt load problems will remain the key driver for yet more contagion.

Related links:
Greek covered bonds to the rescue? – FT Alphaville
The EU must step toward fiscal and political union – Peter Mandelson
The Vienna Initiative is already here – FT Alphaville

This entry was posted by Neil Hume on Tuesday, June 28th, 2011 at 9:57 and is filed under Capital markets. Tagged with , , , , , , , , .

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