Sarkozy Whistles Past The Graveyard

Includes: FXE
by: Craig Pirrong

Nicholas Sarkozy said this about Greece: “”Today the problem is solved.”

Uhm, not so fast, Sarko. The Greek economy is imploding. The political situation there is still fraught. The feasibility and credibility of the austerity pledges are highly questionable. Realistic forecasts suggest that even with the 100 billion or so (largely coercive) writedown in government debt, Greece’s obligations are not sustainable.

The markets are already giving their verdict. The new Greek debt (to be issued to private holders of the old debt) is trading on a when-issued basis at very high yields:

Markets showed investors have no faith that the bond swap will draw a line under the country’s troubles. Under Greece’s austerity and reform programme, its debt burden in 2020 should fall to where Portugal’s is now.

If investors believed Athens could succeed, yields on Greek and Portuguese bonds should be similar. But on the grey market, the new Greek bonds were yielding 17-21 percent, far above Portuguese levels around 11-14 percent.

And it’s not like Portugal’s yields are any great shakes. Indeed, Portugal is itself at serious risk of default.

What do 17-21 percent yields mean? Here’s what they mean:

Initial quotes in the “when-issued” market for the new Greek 2042 government step-up bond range between 17% and 22% of face value, according to traders with knowledge of the matter. Small-sized trades are going through the broker market as dealers “test the water,” according to one trader.“We are quoting the new 2042 bond between 20 and 22 cents to a euro…there is some interest to trade these securities but volume is still quite small,” said a London-based market maker.

Sarkozy is whistling past the graveyard. Official European entities, like the ECB, are Greece’s primary creditors. All of Europe is on the hook for its debts: the effective subordination of the new debt in private hands is a main reason why the new debt is trading at such heavy discounts, but even given the senior status of Greek debt in official hands, it is unlikely those official creditors will receive full payment. Given the imploding economy and potential for political backlash in Greece, it is rather naive to think this is solved. This may be the end of the beginning, but it is nowhere near the end.

Europe might have bought some time, but the key thing is what they do with it. Sarkozy’s confident statement suggests they may well be wasting it.