Notes From Underground: Looking Backwards One Week

On November 19, 2012 I wrote a blog post about France getting a yellow card from Moody’s. In that post was another item about a Reuters story, “Germany Floats Idea of Greek 25-cent -on Euro Debt Buy Back.” Well, the importance of looking back is because that Reuters LEAK from Germany was virtually the agreement that was reached by the European policymakers in a short-term resolution to assuage the IMF and other Greek creditors. It is another example of the necessity of paying attention to official sources and leaks. I will re-post that NFU in its entirety with the link to the Reuters article. Preparation is the key to successful trading and investing.

***A very important point was raised in a Financial Times article by David Gardner in reference to the Catalan election. Mr. Gardner downplays the election victory by the secessionists and notes, “The stated goal of making Catalonia a ‘new state in Europe’ sounded less thrilling, moreover, once the penny started to drop that it would have to seek readmission to the EU after the independence and that Spain would have a veto.” This is a significant variable in the politics of the entire Spanish issue as the outcome will by definition be settled by fiscal and financial designs–very similar to the way the UK plays tough on the EU budget negotiations.This is confirming what NFU reader Victor Hernandez posted in a blog note yesterday. European solutions will never be easy.

***Yesterday I wanted to link to a Bloomberg piece by Alexandra Harris detailing out issues on collective action clauses. There isn’t a link available so I will list some of the more important concerns mentioned in the piece:

The March 2011 ESM Treaty requires euro area bonds to be issued with CACs and that takes effect January 1,2013. The recent ruling on the Argentinian debt problem may well mean that investors will balk at CACs and demand a higher yield to offset their concerns. The Bloomberg piece draws on the work of Julian Wiseman and Vincent Chaigneau and Ciaran O’Hagan of SocGen.
  • Makes it easier to restructure debt undermining any attempt by minority investors,to ‘free ride a debt restructuring’. “This is important for Europe will the ECB or ESM may well be the super majority holder of a nation’s debt and thus force a very stringent restructuring upon those private sector debt owners.
  • Significant  long-term consequence on degree of trust investors place in sovereign credit;
  • Governments have increased power to modify terms on multiple bonds, also known as cross-series modification, which reduces power of investors to block modifications and thus the holdouts have no leverage;
  • As the OFFICIAL SECTOR increases its holdings of Sovereign Debt in Europe, the amount of debt bearing the CACs in the hands of ECB/ESM/EFSF is going to provide the borrowers with overwhelming negotiating power.

As the debt crisis moves into new venues the issue of CACs is going to be front and center in the discussions, especially after the recent New York District ruling–just trying to prepare the readers for the coming arguments. Also read the May 7, 2010 piece by Buchheit and Gulati on “How to Restructure Greek Debt.” Mr. Buchheit is considered the dean of all lawyers in representing the sovereign borrowers in debt restructuring. (He is from the law firm of Cleary Gottlieb.)

From November 19, 2012:

Notes From Underground: Moody’s Hits France With A Yellow Card

Well, Moody’s downgraded the France’ sovereign rating from AAA in what was an obvious bow to reality. MOODY’s, WHAT TOOK YOU SO LONG? This will really be a bitter pill for President Hollande as it was only last week that the “French cock” was crowing about how well the bond markets were evaluating his performance as the leader of France. I reminded readers that the recent performance of the French debt had more to do with Mr. Draghi’s aggressive actions than any policy put forward by the Hollande government.

In the Moody’s statement about the downgrade it cited the following concern about France:

The risk that greater collective support will be required for weaker euro area sovereigns has been rising, most for notably Spain whose economy and the government bond market are around twice the combined size of those of Greece, Portugal and Ireland. HIGHLY RATED MEMBER STATES ARE LIKELY TO BEAR A DISPROPORTIONATELY LARGE SHARE OF THIS BURDEN GIVEN THEIR GREATER ABILITY TO ABSORB THE ASSOCIATED COSTS. (emphasis mine)

It seems that Moody’s is terrified of the adverse feedback loop that will affect a fragile French economy. The greater the economic downturn in the euro zone caused by the German-demanded austerity budgets, the more negative impact on France. The ESM is a construction of all the EU members and thus will drain the French treasury in an effort to meet its regional obligations. If President Hollande is to provide more cash for bailouts and still meet his 3% deficit number, it will mean even greater cut backs for the domestic economy.

The proof will be in what the markets do to the French/German debt spreads as President Hollande advised us last week. At today’s close, the German/French 10-year bond spread was a 72 basis point differential. This will be a point of reference going forward.

***While remaining in Europe, Reuters News ran an interesting story,“Germany Floats idea of Greek 25-cent-on Euro debt buy back.” It seems that Germany is proposing that private sector debt holders sell their remaining Greek debt (about 30% of the total) at 25% of face value and the Greeks will be lent the money by the Troika so it can buy in high-yielding debt and contract some of the onerous interest payments. The Germans maintain that the official sector cannot take a haircut on their holdings for that would violate the present EU treaty on financing sovereign bailouts. The EU authorities would then move to lower the interest rates on Greek debt that the ECB and EFSF now holds. 

As the interest rate is lowered, the maturity of the loans would lengthen, thus effectively doing a major restructuring and granting the Greeks more “time,” and alleviating the immediate budget pressures. This is as close to a 1980s sovereign debt restructuring as we have seen. The only question is: WILL THE PRIVATE DEBT HOLDERS OBLIGE OR PRESS FOR A BETTER DEAL? There will be a “game of chicken” as some of the hedge funds are now sure that the EU/Germany will not let Greece go as the price of default for the EU system is too great relative to the cost.

The German’s are just searching for the immediate price from private debt holders. Greece is small change compared to what Spain will cost–so get the easy one out of the way and prepare for a much bigger problem. If the private debt holders accept it, this will be deemed a positive by the markets,bat least for the moment. Time to return to the May 2010 articles by Buchheit and Gulati: “How to restructure Greek Debt.” 

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