The Great Debate UK

from The Great Debate:

A good deal for Greece, its creditors, and Europe

Amid all the doom and gloom about Greece in the last few weeks, it is easy to overlook an important piece of good news: the debt exchange offer published by Greece on Friday with endorsement by its main private and official creditors. If implemented, this would be a major achievement and an important step toward overcoming the euro zone crisis, almost regardless of what happens next.

Under the offer, bondholders would receive 15 percent of the face value of their bonds in the form of short-term European Financial Stability Facility (EFSF) bonds, plus a set of new Greek sovereign bonds maturing between 2023 and 2042, with a 31.5 percent face value.

This agreement is a very good deal for Greece. The combination of the cut in face values, lower coupons and (in most cases) longer maturity implies a debt reduction of about 60 percent in present value terms (evaluated at a 5 percent discount rate). Assuming high participation (about €200 billion in bonds), this translates into savings of about €120 billion, or 54 percent of Greece’s 2011 GDP. This is very large. By comparison, the Argentine exchange of January 2005, the previous high-water mark, generated present value of debt relief of only about 29 percent of GDP, because although the per-dollar debt reduction was higher, the volume exchanged was much smaller.

Private creditors are also getting a good deal. Although they are being hit hard, they could have done much worse. You will see claims that the “haircut” suffered by creditors is on the order of 75 percent. These are exaggerated, because they compare the present value of the new bonds with the face value of the old bonds. But in a pre-default debt exchange, creditors never have the right to full immediate repayment. They only have the right to keep their old bonds and expect them to be serviced.

A better way to determine the value of the new bonds is to compare them with the present value of the old bonds, assuming they both are subject to the same default risk. This leads to a haircut of about 65 percent -- much less than what creditors would have lost in a disorderly default. And it does not reflect two additional benefits: “GDP warrants” that may deliver extra payments beginning in 2015, depending on the level of Greece’s GDP; and an effective upgrade in creditors' rights compared with those of the old bonds. The new bonds will be issued under English law, making them harder to restructure again in the future, and their repayments will be linked to repayments to the EFSF.

Finally, the agreement is a good deal for Europe -- not because it guarantees a good outcome, but because it takes some really bad outcomes off the table. The risks of the new EU-IMF package for Greece are well-known: It assumes a large and protracted reform effort in an economically depressed country where both politicians and the “troika” are deeply unpopular and social tensions are high and rising. And even if the debt exchange is successful, Greek debt will remain very high. Yet the proposed debt exchange and the program that underlies it differ fundamentally from previous instances of “kicking the can down the road.”

Take the worst-case scenario: Following the debt exchange, the program goes offtrack in just a few months, and Greece is cut off from any further borrowing. This would aggravate Greece’s economic downturn and force it into even more austerity to avoid running a primary deficit. But it would no longer lead to a catastrophe. Assuming high participation in the exchange, Greece would face almost no net debt repayments in 2012 and just €1.25 billion in interest payments on the new bonds in 2013. Hence, it would not need to default, let alone leave the euro. Furthermore, Greece would no longer represent a contagion threat, and with a recapitalized banking system, and little or no remaining government deficit, it could likely manage its crisis on its own -- at least until large repayments to official creditors begin to fall due in 2014.

A 6-1 defeat is not a draw

Michael Gove trying to laugh off Monday’s rebellion by 81 backbenchers sounds like a United supporter arguing that 6-1 was more or less a draw. For all the excuses, he can’t hide the fact that the government’s position is full of contradictions.

On the one hand, the PM has added his voice to the chorus calling for the euro zone to turn itself into a monetary-and-fiscal union, a proposal which certainly goes with the grain of the crisis. The idea has the support of the Americans and would probably be warmly welcomed in Asia too. In fact, it has great appeal everywhere except in the euro zone itself, where the main protagonists themselves have got a severe attack of cold feet.

And no wonder – they are being asked to accept what amounts to full economic integration: a huge decision taken more or less on the hoof, in the space of a few weeks, whereas they are only too well aware that it took the best part of a decade of consultation, summits and referenda to overcome the opposition to monetary union – and in the end their victory really was almost a draw.

However, fiscal integration is by no means a done deal, nor is it remotely certain that fiscal integration will solve the immediate problem, given that the crisis has already reached France and is directly threatening Germany’s own creditworthiness. But if such far-reaching changes are afoot within the euro zone, you would expect the government to be putting forward a clear vision of where it sees Britain fitting into the new architecture, rather than merely providing unsolicited advice which is bound to be both ignored and resented.

If fiscal integration does go ahead, it will confirm the two-tier model of Europe, with an inner core of countries run by a single government controlling all aspects of macroeconomic policy (and most of microeconomic policy too), and an outer tier consisting of… of what exactly?

This is a real opportunity for Britain to reshape its place in Europe, as the largest of a bloc of countries mostly on the periphery that are part of the single market, but which retain full economic sovereignty – control not only of their own monetary and fiscal policies, and their own currencies (and hence interest rates), but also of their own tax rates and their own regulatory authorities too.

Notice this is not a total retreat into a customs union. Apart from the fact that there is more – though not a lot more – to the EU than economics, it would still allow free movement of capital and, more controversially, of labour. Ending the latter would no doubt be popular, but stupid for a number of reasons. In the first place, most of the problems arising out of immigration are associated with arrivals from outside Europe. Secondly, in reality it is almost impossible to stop immigrants arriving, legally or illegally, even from outside Europe, let alone from, say, Poland or Slovakia. Thirdly, on purely pragmatic grounds, if we are ever to get what we want in Europe, we need all the support we can muster – and the Eastern Europeans will be far less supportive if we slam the door in their faces.

Another week, another E.U. bailout agreement

By Mark Hillary. The opinions expressed are his own.

Once again German Chancellor Angela Merkel has had to dig deep to ensure that the euro zone can limp along for a little longer without any single nation defaulting.

And this story changes day by day. No sooner has Germany rescued the euro, Greece apologises and says they can’t meet the deficit targets – no more savings can possibly be achieved through austerity.

But as economists chart the course of this rollercoaster ride of expected default and the potential catastrophe of the entire European single currency project unwinding, is anyone paying attention to the social effect of all this uncertainty?

I don’t mean the pain of the middle classes ruing the days their house would increase in value week by week, I mean the potential for a completely different system of politics.

The political answer to the crisis in Europe is austerity. Public sector jobs are being slashed, taxes are being increased and more widely enforced, and state services normalised over decades are suddenly being cut.

Yet faith in centre-ground politicians is possibly at its lowest ebb since the end of the First World War. The general public has a very low tolerance for their elected leaders at present and non-economists generally view austerity packages as the wrong approach for repairing damaged economies.

Could Europe be on the cusp of a Lehman moment?

By Kathleen Brooks. The opinions expressed are her own.

The euro zone debt crisis has now spread from the sovereigns – after the ECB came in and purchased Italian and Spanish debt – to the banking sector. Although the EU authorities put in place a short-selling ban, which has another week to run, the banking sector is back at the pre-ban levels or in some cases even lower.

Europe’s banks are by and large less capitalised than their U.S. peers. They are also exposed to Europe’s sovereign debt and European loan books. Even if a member state manages to avoid a default, growth is now slowing and we could be in line for another recession that would most likely increase bad debts and further erode banks’ profits.

As if that wasn’t enough, German Chancellor Merkel and French President Sarkozy announced a proposal for a financial transactions tax – a Tobin tax – to pay for bailouts to Greece, Portugal and Ireland. This will be discussed at the next EU summit in September, and if implemented would only make it harder for banks’ to boost their capital bases going forward.

The Basel three global regulatory standards for bank capital adequacy requires the world’s largest banks to boost their Tier 1 capital ratios and to hold higher quality capital as a buffer in case of financial shocks in future. These rules were introduced this year and since then Europe’s banks have been in a rush to raise capital. Pressure was ramped up after stress tests that were released in June showed that 24 banks needed to raise extra capital. Eight banks failed the test, while 16 had core tier 1 capital ratios below the 6 percent threshold.

So the banking sector in Europe was already exposed even before growth started to slow and the sovereign crisis spread to Italy and Spain. If markets get a hint of trouble in the banking sector the rumour mill can go into overdrive. This has driven stocks like Unicredit and Societe Generale lower by 30 percent and 40 percent respectively since the start of August.

Earlier this week there were rumours that some banks had to borrow dollar-based funds from the U.S. Federal Reserve’s swap facilities for foreign banks. This is considered the lender of last resort when you can’t raise money from the inter-bank market. The sums were fairly minimal – EUR500mn and EUR200mn – however, they suggest that some European banks are in trouble and a liquidity crunch could be in the wings.

Greece deal is a compromise and, once again, the banks have won

By Laurence Copeland. The opinions expressed are his own.

Whenever I see photos of Chancellor Merkel these days, I’m reminded of the lugubrious features of the creature in the Restaurant at the End of the World, as it recommended to guests which part of its own anatomy they should eat. The details of the “Deal to Save the Euro” are still mysterious and have been given a misleading spin in the official releases, but one or two points seem clear.

First, the package is a compromise – a little bit of default (as required by a reality check) plus assistance to Greece which looks very generous but is still not enough to give it a realistic chance of paying its remaining debts. So the can has been kicked further down the same road yet again.

The second point is one I am as fed up of writing as you probably are of reading: once more, the Banks Have Won. On the one hand, the French President wanted some kind of blanket balance-sheet tax, supposedly to contribute to the cost of the bailout. This was a daft idea for all sorts of reasons, not least the fact that it would have penalised the banks which behaved responsibly along with the irresponsible, the sort of outcome we have seen only too often in the last three years.

Germany, or at least Angela Merkel, wanted a solution which involved some contribution from the private sector creditors (mostly the banks, of course), which she has in the end got. Now the first thing to be said is that the words “private sector” ought to be in inverted commas, because we have seen time and again since 2007 how, one way or another, bank losses end up being borne by the taxpayers, so that any serious hit on the banks would have been deflected on to the public sector anyway.

And then, of course, the British banking sector is half state-owned in any case – all of which begs the question: why all the fuss? Why were negotiations held up for weeks over the issue of how much the private sector should contribute?

In the end, how much are the so-called private sector lenders going to contribute to the rescue?

Ben Bernanke could teach the EU a thing or two

By Kathleen Brooks. The opinions expressed are her own.

Markets thrive on certainty. Anything that smacks of uncertainty, fence-sitting or indecision will lead to market turbulence, as investors punish those who don’t tell them how it is.

This is exactly what we are seeing in Europe right now. The markets are losing patience with the EU’s inability to come up with a credible plan to fight the sovereign debt crisis and that is why it is escalating at an alarming rate.

In general, investors in credit markets are a canny bunch. Bond spreads between Germany and Greece, Ireland, Portugal, Spain and Italy have already blown out, but in recent days spreads between Germany and France, Belgium and even Austria have increased to their widest level for more than two years.

So what does this all mean? In short it suggests that bond investors are going off Europe, even those members who were previously considered safe are no longer out of harm’s way. The credit markets are turning against the political make-up of the currency bloc and until concrete changes are made to the structure of the euro zone the pressure on European credit markets is unlikely to abate.

The various branches of authority in the Eurozone seem to lurch from one crisis to another. Because there is no central voice or authority you end up with a cacophony of voices talking at odds to each other that confuses the markets.

For example, Germany and the ECB continue to play out their differences in public on whether private investors in Greek debt should take a loss. A new low was when the EU President confirmed an emergency summit would be held last Friday, which some member states didn’t even know about.

Another day, another crisis

By Laurence Copeland. The opinions expressed are his own.

Here we go again – the same sickening feeling, as stock markets reel amid a flight to “safety”. For months, there have been worries about contagion from the Greek imbroglio, and now the nightmare seems to be coming true, as one after another the weak European economies are put to the sword.

First came Greece and Ireland, then Portugal, now it’s the big league – Spain and, even bigger, Italy (and don’t forget Belgium, an accident waiting to happen for many years now, not very important in pure economic terms, but psychologically significant as the home of the whole sorry euro disaster).

In the table below, you can see how much Governments were being forced to pay for borrowing on the markets yesterday (July 11). The rates quoted for Greece, Portugal and Ireland imply that borrowing in the bond markets is for all practical purposes out of the question for those countries, as that has been the case for some months past, but the new development is that Italy and Spain are now being forced to pay 6 percent for 10-year loans, a premium of more than 3 percent compared to Germany.

Europe’s bigger crisis waiting to happen

By Kathleen Brooks. The opinions expressed are her own.

So it looks like Greece has staved off default for another few months at least. Investors are breathing a sigh of relief and buying up risky assets like the world is a rosy place again.

The markets always suffer from a chronic case of short-termism, but once a sovereign debt crisis takes hold it is very difficult to reverse. Investors may be concentrating on Greek, Irish and Portuguese funding needs for the next 24- 36 months now, but it won’t be long before investors start to scrutinise longer-term liabilities that are currently being clocked up for the next 10,20 even 30 years.

The bigger beast that threatens Europe’s solvency is the demographic and entitlements crisis. While a lot is known about Europe’s aging population, the scale of the problem and its urgency are not well understood.

The IMF predicts that Greece will have the second highest growth in pension costs as a percentage of GDP in the G20 by 2030. Spain and Belgium aren’t in great shape either. Interestingly, by 2030 Italy and Germany will actually see their pensions’ costs start to fall, but that is because their populations are aging so fast that the bulk of their pension spending will be done in the next 10-15 years.

In Germany and Italy the demographic damage is done.  Research from Eurostat predicts that by 2040 there will be less than two people of working age for every retired person in Germany and Italy that compares with just over three today. In France things are slightly better as there will be just about two workers for every retired person. These statistics tell a bleak story, with this type of demographic shift it is inevitable that living standards will deteriorate in the next decade or so.

The fiscal crisis of the future could also have a domino effect. Once investors realised there was an enormous hole in Greece’s public finances they started to punish Ireland, Portugal, Spain and even Italy saw its bond yields rise. In the future investors may start to punish the credit markets of those countries with poor demographics.

Trichet’s United States of Europe?

By Kathleen Brooks. The opinions expressed are her own.

Another week another round of EU officials proposing solutions to the Greek insolvency problem.

First there was the President of the European Council Jean Claude Juncker who suggested that bond holders could be tempted into rolling over their maturing debt and buying more Greek bonds as long as a few sweeteners like higher coupon or interest rates were thrown in.

But while this will plug short-term financing needs it is still only adding more debt to Greece’s enormous debt pile and not dealing with the core problem:  the financial malaise at the heart of the euro zone that allowed Greece to get away with a flagrant breach of fiscal rules for years.

It came down to Jean-Claude Trichet, whose tenure as President of the European Central Bank (ECB) comes to an end in October, to suggest a long-term solution that would hopefully avoid another debt crisis, but would also require a degree of economic centrality never imagined by the euro zone’s founding fathers.

His idea is for a euro zone-wide Ministry of Finance that would have three critical powers. Firstly, it would be in charge of ensuring adherence to fiscal and competitiveness policies, secondly, it would control the region’s financial sector and thirdly it would centralise representation of the currency bloc in international financial institutions like the International Monetary Fund (IMF). “Would it be too bold?” the Frenchman shrugged as he spoke of his dream at a ceremony in Germany where he picked up the highly coveted Karlspreis.

While Trichet didn’t go as far as to suggest his ministry should control state budgets or issue debt, it is still an extremely interesting idea that – if implemented – could re-invigorate the currency bloc.  Firstly, fiscal integration is often considered the missing piece of the united Europe puzzle. Without actually controlling states’ revenues and expenditure directly, Trichet’s plan would give the EU direct powers to alter the course of national economic policy. For example the central ministry would have if it thought they could jeopardise the financial health of the member.

Defining a post-crisis reputation for brand Ireland

– John Keilthy is Managing Partner of ReputationInc Ireland and is a former business journalist and director and chief operating officer of NCB Group.  Andrew Hammond is a Director in ReputationInc’s London office and was formerly a UK Government Special Adviser. The opinions expressed are their own. –

In recent weeks, the focus for Ireland and indeed the world’s financial markets has been on devising a plan to remedy the country’s precarious banking and fiscal affairs.

With the basis of an agreement having been reached with the IMF and the EU around initiatives to help restore Ireland’s financial credibility internationally, there is now a need to focus attention on restoring the nation’s reputation.

The economic and financial problems that the country faces are still daunting.  However, the nature of the crisis is, in truth, much broader and more serious in as much as the entire foundations of Ireland’s nation brand have also been undermined.

The concept of nation brands is founded on the realisation that, in an ‘overcrowded’ global marketplace, countries are, in effect, competing not just for the favour of investors and the wider financial community, but also for other globally focused stakeholders such as tourists, media, skilled employees, regulators and NGOs.

Thus, economic and financial fundamentals, such as a country’s fiscal position, tax regime, trade balances and business climate are only the most obvious elements of what drives international prosperity, with wider competition between countries, such as that for global talent, also key.  In this ultra-competitive environment, reputation can be a prized asset (or potentially a significant liability) with a direct effect on future political, economic, social and cultural fortunes. Successful countries identify their image and key strengths, and prioritise the appropriate policies to strengthen such attributes.

Countries with a range of branding problems right now, such as Ireland, Greece, Israel, and China, face an uphill battle changing the perception others have of them. However, history has shown that reputation can be recreated and once again become a key driver of not only national pride, but also economic success and what flows from that in terms of wider social and cultural benefits.