Economic News & Analysis - March 9, 2012
Greek debt: Clearing the way for more pain
By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist

Brian Jacobsen photo

Summary:

  • More than 85% of the market value of private-sector investors of Greek debt agreed to a proposed debt swap.
  • Greece will likely invoke collective action clauses (CAC), raising the participation rate to more than 95%.
  • Most likely, the use of CACs will trigger credit default swap (CDS) payments.
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At 1 a.m. Eastern Time today, the Greek government announced that private-sector investors holding 85.8% of the market value of Greek debt had agreed to a debt swap that will significantly lower Greece’s debt burden. To increase the participation rate to 95.7%, some investors will be dragged along as the Greek government likely invokes CACs, which will force the deal on hold-out investors. It is expected that the use of CACs will trigger CDS payments. Fortunately, the CDS payments will probably not cause many problems for the financial system as there is only a net $3.16 billion of CDS contracts outstanding.

Approximately 206 billion euros of debt held by private-sector investors was subject to an offer by the Greek government that would cut the face value of the debt by 53.5%. This agreement would replace the outstanding debt with new debt featuring lower interest costs and a longer time to pay and could cut the value of the outstanding debt held by private-sector investors by upward of 73%. While that’s a significant cost savings, it may be inadequate to permanently fix Greece’s problems.

More money needed?

Greece will likely receive its second bailout package from the International Monetary Fund (IMF) and the European Commission (EC). The first bailout in May 2010 totaled 110 billion euros; this second one will be for 130 billion euros. In order to secure the second bailout, the Greek government needed to clear a number of hurdles, one of which was getting private-sector investors to agree to the debt swap.

The IMF and the EC has set a goal to lower Greece’s debt-to-gross domestic product (GDP) ratio from its current level of 160% to 120.5% by 2020. To lower the ratio, the debt reduction needs to exceed the GDP reduction, or the level of debt needs to grow more slowly than the GDP. Only if Greece’s economy returns to positive growth by 2013 and if the government meets its budget goals will Greece move forward without another bailout. After shrinking more than 12% since 2009, I think Greece’s economy can still shrink at least another 7%, if not 10%, before returning to growth. That would be in line with what we have witnessed in Argentina, Russia, and Mexico—countries that have all gone through similar debt pains.

Although the debt restructuring will help Greece in the short term, I believe we will see a replay of this Greek debt saga within the next few years when additional money is needed. There is also a strong possibility that there will be additional strife before the end of 2012 as France elects a new president in April and Greece holds its own elections shortly. Some of the leading candidates have pledged to renegotiate the deals struck over the past few years. It appears as though the Greek tragedy is turning into a never-ending saga.

Read our blog post on today’s employment situation report.

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