We’re feeling very nostalgic. From the WSJ:
Euro-zone countries are considering a proposal that would see Greece cut its debt by buying back bonds held by private creditors at a discount.
The exercise–one of a number of options being studied–could persuade the International Monetary Fund to sign off on a loan payment desperately needed by the debt-laden country and keep Greece’s bailout on track for the medium term, two officials with direct knowledge of the discussions said Thursday.
One of the officials said the plan, originally floated in the middle of last year but dropped, was being promoted by the European Central Bank. The ECB declined to comment.
The bonds would be bought at a discount from private bondholders by the Greek government but it could then deduct 100% of their face value from its total debt, making its debt appear more sustainable compared to the size of its economy.
“It involves a voluntary exercise. The theory that if those holders want to exit Greece now you agree on a premium and Greece writes off the remainder [of the face value],” one of the officials familiar with the plan said.
First impression: buybacks have their advantages but still take cash. That will have to be found… and Germany wasn’t too keen on shelling out for such a scheme last time. From the WSJ again:
German opposition to advancing funds to Greece was a factor behind the similar proposal in the middle of 2011 being dropped. That opposition has since become stronger.
Second impression goes to Citi’s Valentin Marinov: he’s calling the idea, if it goes ahead, PSI2 (albeit more market friendly, obviously):
As part of the PSI deal private bondholders swapped about EUR200bn of Greek debt for 100bn of new Greek bonds (67%) and EFSF bonds (33%). The current 10y Greek benchmark bond trades at about 35% discount of par, implying a haircut of about 65%.
If confirmed the headlines could be pointing at PSI 2. Greece will be allowed to reduce its debt by almost EUR50bn leaving its liabilities consisting almost exclusively of debt held by official accounts. PSI2, if confirmed, could add to the headwinds for EUR:
1. It need not resolve the Greek debt issue with Citi’s economists expecting even greater debt restructuring involving Official Sector Involvement or OSI. As such it will be seen as only temporary relief for the struggling Eurozone member state.
2. PSI2 could rekindle concerns about the debt sustainability of other struggling peripheral states like Portugal
3. PSI2 will likely increase the overall haircut on Greek debt to almost 90%. This could undermine the credibility of any first loan guarantee insurance used to leverage the ESM if the level of protection is seen as inadequate.
Third impression: the fact that Asmusses is talking about it publicly makes us pretty skeptical. Surely he’s savvy enough to understand the consequences. Something the WSJ’s piece appreciates (with our emphasis):
Also disclosure of the plan would cause the bonds to rise in price, making the exercise less effective than it appears on paper today. The official said, “The problem is that those bonds will shoot up in the market if this becomes the preferred option.”
…
The idea of a bond buyback was first made public by ECB board member Joerg Asmussen in Tokyo. In comments reported by German daily Sueddeutsche Zeitung, he indicated that the resources of the European Stability Mechanism could be used to reduce Greece’s debt level to a sustainable level by buying back Greek bonds held by the ECB.
“We have to think in the coming weeks about solutions such as a voluntary debt buyback,” Mr. Asmussen was quoted as saying, but he didn’t elaborate. Officials are now saying this idea is being developed and discussed.
(And we’ve been told this idea was floated a few weeks back in Athens and worried private investors. Not that surprising it’s been spread around then…)
That brings us to our fourth impression, alluded to above: this ain’t new.
Over a year ago Exotix’s Gabriel Sterne was referring to a similar plan as ‘The Buyback Boondoggle’ (with approriate Rogoff hat tip). From Sterne back then:
A boondoogle is a term for a scheme that wastes time and money. This applied to Bolivia because the buyback price was too high to restore debt sustainability. The authors asked “If the total market value of Bolivia’s debt was only $40 million before the announcement of the repurchase plan, why did it cost Bolivia $34 million to buy back less than half the face value of the debt?” And they claim “viewed in isolation, the buyback appears to have been a giveaway to creditors.” The general point is that buybacks may tend to take place above the price required to restore debt sustainability. A specific point in the Bolivian case was that the very act of publicising the possibility of a buyback drove prices up and gave Bolivia a poor deal.
And, finally, Sterne says of the present case:
Another big issue is that this is new money going in to retire debt that doesn’t start to mature for 10 years. Is that the best use of resources when the banks are so far underwater they are doing next to no new lending.
We shall await more details, or none.
Related links:
A Greek buyback boondoggle – FT Alphaville
A primer on sovereign debt buybacks and swaps – IMF (2007)
The buyback boondoggle -Rogoff and Bulow (1988)
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