Eurointelligence Daily Briefing, 27 de Outubro de 2011. Enviado por Domenico Mario Nuti.


A deal at last, but what now?

  • EU leaders reach a final agreement on all aspects of their comprehensive package at 4am this morning;
  • the sticking point was the negotiation with the Institute for International Finance (IIF) over a “voluntary” haircut;
  • the deal agreed is a 50% haircut – for a total of €100bn – plus a €30bn contribution from the eurozone;
  • Greece will supply more privatisation receipts than already planned;
  • EU will step up surveillance of the programmes, and strengthen its representation in Athens;
  • initial market reaction to the agreement is neutral to mildly positive;
  • FT Deutschland says EU leaders made an offer that banks could not refuse;
  • IIF has until end of the year to deliver the voluntary participation;
  • there was also an outline agreement on the EFSF, under which both schemes – bond insurance and the CDO – could run concurrently;
  • goal is to leverage the EFSF by a factor of at least four, to reach a total leveraged volume of up to €1 trillion;
  • finance ministers to work out details in the next few weeks;
  • Herman van Rompuy said leveraging was no big deal, since banks have been doing this for centuries;
  • EU leaders earlier settled on a bank recapitalisation programme of €106bn;
  • Silvio Berlusconi, meanwhile, presented his structural reform programme, which EU leaders received politely.

There is not much point in a normal newspaper review on a day like this. Instead, we will give you our take on the summit.

It was a cliffhanger right to the end at 4am this morning, but as we expected, the summit reached more or less detailed agreements, including on the Greek haircut. The outlines on the bank recapitalisation package have been reached before, and formally agreed yesterday. In the following we focus on the Greek haircut and the EFSF.


1.     Greece

On Greece, there was a deal with the private banks after all about a “voluntary” private sector participation of €100bn – which comes to a haircut of about 50%. In addition, the eurozone would contribute a further €30bn. On the basis of current official projections, these measures would stabilise Greek debt at a level of 120% of GDP by 2020. They reiterated their commitment to complete the second Greek loan programme by the end of the year, which would provide additional programme finance until 2014. Greece will effectively lose large parts of its economic sovereignty while under the programme, as the European authorities will strengthen their presence in Athens. Greece also commits to greater than previously planned privatisation revenues.

FT Deutschland said this morning that Angela Merkel, Nicolas Sarkozy, and Jean-Claude Juncker made the banks an offer they could not refuse. Either they accept a 50% voluntary haircut, or an even larger haircut will be forced on them.

The European Council said in its statement that this was a unique agreement that applied only to Greece. Of course, such pledges lose credibility once they are broken, as was a similar pledge in relation to the July agreement of a 21% haircut. It will take until the end of the year when the details of this agreement will have been worked out.


2.       On the EFSF

There was an agreement here to, but no more details than those we already published in our previous briefings. The most important noteworthy clarification is that the two schemes – the bond insurance sweetener and what we call the CDO – are not alternatives, but could run concurrently. The goal is to lever the available funds by at least four times, to reach an overall volume of about €1 trillion. There is not much further detail, since the devil with all these complex finance products lies in the contractual small print. All this is now to be settled by finance ministers in the next few weeks.

We thought that the following comment by Herman van Rompuy was noteworthy in terms of the way political leaders are justifying the huge risks they are taking through leverage: “There is nothing secret in all this, it is not easy to explain but we are going to more with our available money, it is not that spectacular. Banks have been doing this for centuries, it has been their core business, with certain limits,” he said last night. (The reason why banks have been able to do this for centuries is because they are backstopped by central banks and governments. The situation changes when the governments themselves act in this manner. There is nobody to pick up the tab if this CDO collapses – if they ever get anyone to invest in this toxic debt instrument in the first place.)


3.       On Italy

As expected, Silvio Berlusconi presented his 14-page letter, which the leaders politely welcomed, while immediately throwing doubt on his ability to pull it off. There was a revealing comment by Jose Manual Barros who said that the key was not the commitment, but the implementation.


Our initial assessment

So is this a comprehensive agreement? Of course it is. They did what they set out to do. Will it solve the crisis? Of course, it will not. The probability that the Greek deal will come unstuck is close to 100%.

First, the banks will in our view not be able to deliver a voluntary participation of €100bn. Many banks would be better off if the haircut was involuntary, given their offsetting positions through credit default swaps. The whole idea for a CDS is to ensure the creditors against an involuntary default. By agreeing a voluntary deal, the insurance will not kick in. We are therefore not yet convinced that the IIF can deliver on such a large number. We therefore believe that there is a significant likelihood that this agreement will end up as an official credit event. The participation in the July agreement was very different. This deal was considered good for the banks. They had an interest in participating for as long as they were assured that this would not trigger further requests for participation, which is what just happened.

Second, even if we were wrong, and the banks did deliver a voluntary €100bn contribution, it is not clear at all that Greek debt would stabilise at 120% of GDP, given the persistent delusion of the EU’s official forecasts for the Greek economy. The increase in the PSI became necessary because the forecast were wrong. The collapse in the Greek economy continues, and there are no signs of the promise expansionary fiscal contraction on the horizon.

And third, even if we were wrong on the haircut, and the economic trajectory – in other words if Greek debt were to stabilise at 120% of GDP by 2020 – this would almost certainly not be regarded sufficient. Just because Italy’s debt-to-GDP ratio is currently at this level does not mean that this is some natural acceptable upper ceiling for countries that have just defaulted. Greece, in our view, will require a much lower sustained debt-to-GDP ratio, perhaps around 80%, to achieve sustainability and access to market funding. This goal remains out of reach, even under these three highly optimistic assumptions.

Regarding the EFSF: As we pointed out before, leveraging the EFSF is dangerous, and ultimately unconvincing in the absence of an open commitment by the ECB that it stands ready to act as a lender of last resort, or by governments that they are to move towards a fiscal union, or ideally both. Mario Draghi yesterday said the ECB was determined to continue the SMP, a statement intended to underline the ECB’s support. But given the stance taken by the Bundesbank and other northern European central banks, the ECB’s further commitment to the SNP remains capped. In our view, the programme will continue, but it will not reach a size of sufficient macroeconomic significance. This is also in line with the way the ECB has managed the programme in the past, doing as little as they need, focusing mostly on securing the short-term stability of the bond markets. While we never believed that the official line according to which the function of the SNP is to preserve monetary transmission mechanisms, it is also not a programme to monetise debt.


Spreads, Forex, and ZC Swaps

No wild market reactions following the announcement. Italian spreads approached 4% yesterday, and marginally better overnight, but still at 3.922% this morning. French spreads have come off a little, while Spanish spreads rose again. The euro was stable at $1.3969 this morning.


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Source: Reuters








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