On the sad algebra of the Greek Debt Buyback

In a previous post, I dissected the recent Eurogroup plan to save Greece (again!). Today I single out the debt buyback operation which is a crucial aspect of that plan.

The net debt reduction that any debt buyback operation achieves is simple to compute: By spending sum S on purchasing its own bonds, at a ‘distressed’ y% of face value, the debtor (in this case the Greek government) can expect a net debt reduction equal to NDD = S times {(100-y)/y}.

The last Eurogroup decision proclaimed a target of reducing Greece’s debt by 40 billion in aggregate. Of that sum, 2 billion would be the result of a reduction in the interest rate payable on Bailout Mk2 loans and another 7 billion will come from the ECB returning to Greece the profits it is making from past purchases of Greek government bonds (in the context of the ill-fated SMP). Which means that a further 31 billion of debt reduction is placed on the shoulders of the debt buyback.

The Eurogroup also decided to set the price at which bonds would be repurchased at y=28% of face value – the price at closing on the preceding Friday. With 10 billion at its disposal, the Greek government would, at best, manage to reduce its debt by 25.7 billion, assuming that Greek banks sell all 15 billion of their holdings and, in addition, hedge funds add another 25 billion (of the 45 they hold) to the pot. We see that, even under these ideal conditions, the debt reduction program agreed at the Eurogroup would be short of 5.3 billion. Alas, the conditions are far from ideal and the benefits will be much, much thinner.

Indeed, since the Eurogroup decision, the goalposts have been moved and the rules have changed. First, the offered price was substantially increased. Instead of a flat 28% of face value, Greece’s debt management authorities (ostensibly with the troika’s permission) have called for a Dutch auction within the wide range of 30.2% to 40.1%. Splitting the difference, and assuming an average price of about 35%, the largest possible net debt reduction is approximately 18.6 billion –  a far cry from the planned 31 billion and still contingent on the Greek banks offering all of their bonds (against their wishes to hold as many of them as possible) and the hedge funds chipping in at least 14 to 15 billion.

While awaiting official briefings on the agreed prices and quantities tendered (with the sound of Greece bankers’ arms being twisted by the Finance Ministry in our ears), one thing is clear: The much heralded Greek debt buyback is a tale of two worlds. It constitutes a reward to hedge funds and a ruthless domestic PSI No. 2 (aka a massive involuntary haircut) for Greece’s embattled banks. Moreover, its effect will be a net debt reduction 40% less than the Eurogroup’s stated target.

Meanwhile, the Greek government is struggling to convince Greek public opinion that its domestic default vis-à-vis the Greek banks does not constitute a… default. That, in the final analysis, the banks are better off. To that effect, the domestic kleptocracy’s loyal press core have been arguing that the banks had already marked government bonds to market (at around 25% of face value) and, therefore, that the banks are making a… profit from the buyback. This would be laughable if it were not so pregnant with malicious propaganda the purpose of which is, clearly, to disguise this latest assault on rationality and on the public interest (both of Greek and European taxpayers).

Consider the history of these bonds: they resulted from last February’s PSI, in the context of which Greek banks (along with all other private bondholders) were forced to accept a swap that diminished the present value of their government debt holdings by 75%. The bonds they received after that default incident, branded PSI for marketing purposes, are now the ones that are being bought back at 35% of face value. Recalling, that last February the banks were promised that, due to the success of the PSI, and in return for accepting the PSI, the new bonds that they would receive would be ‘gold plated’, the banks never marked them to market officially (for EBA auditing purposes, that is) – not even after these very bonds began to tumble in value. Moreover, and this is crucial, Greece’s banks have been posting these same bonds with the Bank of Greece (as part of the Greek ELA) as collateral (with only a 30% haircut), thus securing liquidity on a day to day basis. And now, at a time that rumours of a debt buyback have pushed these bonds prices to above 43%, they are being asked to accept 35% or else…

Or else what? Well, it is a common secret that Greece’s banks are bankrupt and exceptionally eager to get their hands on the 24 odd billion that the Greek government is about to borrow from the EFSF to recapitalise them with. So, when the government is ‘offering’ to buy back their bonds, as a precondition for the recapitalisation, this is an offer that the banks ‘cannot refuse’. Of course the tragedy is that this recapitalisation is, especially now, utterly devoid of logic. To see why consider the cobweb of insanity being weaved presently:

The bankrupt Greek state is haircutting almost 10 billion of the money it owes to Greek banks so as to be allowed by the troika to borrow 24 billion, on behalf of these same Greek banks, in order to recapitalise them and in the hope that this recapitalisation will help stimulate private sector interest in the bonds and shares of these banks so that the banks can begin lending to the Greek private sector again, thus kickstarting the Greek economy with a view to generating the taxes from which the nation’s debt to the troika can be repaid. Meanwhile, because Greece’s debt will, quite obviously, not be reduced to anything like the proclaimed (by the Eurogroup) levels, and given that the banks need much, much more than 15 billions to be properly recapitalised, no private investors will invest in Greek banks (especially as they note that they are tied to an insolvent state), the Greek banks will hoard the money that the state will have borrowed from the EFSF on their behalf (fearing that any decent EBA-ECB audit will find their capitalization ratio extremely low, and thus declare them bankrupt) and, at the end of the day, tens of billions of fresh loan tranches will have (like all those that preceded them) authored another nasty act in the cruel theatre of horrors that is the Greek bailout.

And all this will be described by our leaders and mainstream press as a successful debt buyback program that heralds a new beginning for Greece. Just wait for it!