Bond repurchase from the ECB is gaining ground

The announcement by the European Council President Herman Van Rompuy about calling the EU Summit on Thursday, sparked many scenarios about the - now notorious - solution of the Greek problem

The fact that only a few hours earlier, the German government spokesman Steffen Seibert had said that "a summit would be justified only when the Eurozone countries have agreed on how to support Athens" could no longer be automatically regarded as a preliminary announcement of this solution, as otherwise van Rompuy’s announcement would have lacked meaning. 

But what happened in the mean time to reach this acceleration of developments? Most analysts believe that the results of European banking stress tests coupled with progress in negotiations between the bankers and the IIF in Rome, might be leading to a solution, more accurately a combination of actions, which answers many questions. 

To have a full view of last day’s events we need to go back Friday morning, when the Economist magazine presented an alternative solution for dealing with the debt crisis in Europe. 

The proposal includes the following parameters: Reducing the debt of heavily indebted countries, recapitalizing European banks that will face problems from the restructuring of the Greek debt and the adoption of a policy that will prevent the spread of the crisis of the heavily indebted countries in other Eurozone countries. Essentially, the Economist showed the final proposal that was being negotiated in Rome and in the discussion of IIF with European banks. 

There, for the second day, Charles Dalaras of the IIF tried to elicit a consensus on a plan to repurchase the Greek debt from the bankers, without excluding a parallel adoption of radical measures such as the proposal of the German Commerzbank for a haircut of 30% in the existing bonds and the exchange of the remaining titles with new, 30-year term ones. 

The situation was clarified by the results of stress test that revealed the size of the assistance needed in the banking industry in general and the exposure of banks in the Greek debt. 

And maybe a lot of people are talking about a need for some type of restructuring for Portugal and Ireland, but the challenge for Greece is different: as concerns the 91 banks that participated in the tests, it was revealed that of the entire current Greek debt, 67% is in portfolios of Greek banks, 8% in French banks and 9% in German ones! In simpler words, any discussion involving about foreign bondholders participating in a rollover will have limited, if not nil results. 

Furthermore, the risk of impairment of the capital positions of foreign banks in case of a Greek "credit event" seems smaller now than the original estimates.

And this is where we come back to this morning's Economist scenarios, maintaining that the Eurozone would have to help Mediterranean countries either by buying bonds through the ECB or by issuing Eurobonds.

 

In reality, in order for the solution of the repurchase Greek debt to be viable, the ECB must sell bonds at the current, market price. And the ECB has collected dozens of Greek bonds in the tens of billions at an average price of 75% to 78% of their nominal value from the collateral of the Greek banks and its successive interventions in the secondary market. So, in the hypothetical scenario of debt repurchase directly from the ECB, it is estimated that Greece will reduce its debt by 15-17 billion euros with one single move. 

This scenario has multiple advantages for all: first, the debt repurchase does not constitute a credit event, so it will not allow room or provide excuses for the rating agencies. Secondly, the ECB will not lose funds; thirdly, Greece will reduce its debt considerably and lastly, private banks/bondholders will not record losses from bond sales at prices below those of their original cost. 

Obviously, an alternative solution will be on the table at the Summit, which will probably be a plan for a rollover, an extension for private bondholders who wish to enter the process. The fact is that this solution is evaluated as selective default by rating agencies, but European politicians believe this rating will not last long, not more than 3 months. Time enough to allow the EU some room to breathe and proceed to a more comprehensive policy change. 

3 months? July, August, September. But isn’t this what Schäuble said right from the start?… 

In any case, the summit call for Thursday has a context and possibly a reason too, to the extent that the Greek solution has already been decided upon, a solution that certainly came late enough, but which had to be found eventually.

Because certainly Europeans were very alarmed by the conclusion of the stress tests that the French banks, for example, are exposed at over 300 billion in the external debt in Italy and Spain! And Italy is already "boiling". 

Could this be the time to close the Greek front? We shall see…