Weirdo Greek debt restructuring

To see one story on Wednesday about an imminent restructuring of Greek debt may be regarded a misfortune. To see two…

Via Reuters:

Officials in Germany’s finance ministry are preparing an emergency plan to handle the fallout if Greece defaults or needs to restructure its debt, sources with direct knowledge of the matter said.

One source close to the finance ministry said German civil servants were analysing what a Greek restructuring would mean for German banks as well as the stability of the euro zone.

“They have started to consider the unthinkable,” said the source…

Via Bloomberg:

Greece would be allowed [by Germany] to buy back government bonds with funds from the European Financial Stability Facility made available to Greece “with favorable interest conditions,” Die Zeit said in an e-mailed release today, without saying where it obtained the information.

Note the mention of ‘funding’ and ‘buybacks’. Not (for example) getting the EFSF to buy Greek debt in the secondary market at a discount and then sell it on to Greece at a further discount, which we’ve considered. We’ll return to exactly what ‘restructuring’ is on offer here presently.

First though, some debt politics.

The Greek and German finance ministries denied both stories pretty sharpish on Wednesday. But the juxtaposition, to be frank, is curious, and so are the purported sources: Germans. It all fits in with this idea germinating in a few market heads that eurozone leaders are (at last) trying to get ahead of investors in constructing policies to fix the euro crisis. That would probably involve writing down debt that’s already weighing down peripheral governments versus ‘supporting’ them with new stuff — bailout loans that actually have quite high rates and shred the maturities of their debt.

Triage, basically. That’s the politics here.

As for the procedure of buybacks and funding, the questions are these:

a) How do debt buybacks fit into restructuring plans?

b) Will Greece taking fresh EFSF loans to fund them work?

c) And, not least: who’s holding the bonds to be bought back?

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What’s a sovereign debt buyback, then?

There is a tricky distinction in this first question, actually, and it’s not mere pedantry over definitions.

Buybacks of government bonds happen to be pretty normal procedure for many a sovereign in the market, without being actual restructuring. More like ‘liability management’. Here’s a bit from Italy’s guidelines for managing its debt in 2011, for instance:

EXCHANGE AND BUY-BACK OPERATIONS

In 2011, as in the last years, the Treasury will avail itself of exchange and buy-back transactions to manage the refinancing risk, by changing the maturity profile and favouring at the same time liquidity and efficiency in the Government bond secondary market…

The Treasury, as usual, will decide each time how to execute the exchange operations by auction conducted by the Bank of Italy or by means of the electronic trading system.

Any buy-back operations will be conducted by auction or through bilateral trading.

All very normal, all very useful to the Italian Treasury — which has a mountain of debt stock to manage and to keep liquid at any one time. That’s liability management for you.

Unfortunately the distinction is a bit blurred these days, thanks to events in bank debt. Anglo Irish used ‘liability management’ as its euphemism of choice for describing tough haircuts on subordinated bondholders, for instance.

However, the important point is — Italy can easily finance buybacks by placing new debt to markets. Greece, being where it is in the market — frozen — can’t. Accordingly then, someone has to fund it for them. But there’s also another problem — convincing creditors to sell bonds back, based on their current reduced prices, or even to make bonds tradable rather than held to maturity.

After all, if Greek banks released their substantial HTM holdings for selling in a buyback operation — the mark to market losses might be huge. In that case, there might be a special reason for external help.

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Enter… the EFSF

Now, the EFSF. The Die Zeit report isn’t quite how we imagined the EFSF would be used for restructuring Greece’s debt – as per focus on possible direct EFSF purchases of peripheral debt in recent days. If EFSF buying of Greek debt was at a price below par value (say – 80 cents in the euro instead, the current market price) it’s effectively a haircut, for instance. The more so, should the bonds then be sold to Greece at a further discount.

Instead, it looks like we’ll get low rates from the EFSF (below 5.8 per cent, the going rate for the Irish bailout? Closer to its own likely 3 per cent funding costs?). We’ve a slight reservation here as this is going to involve Greece taking on new official debt even as it retires some old private-sector stuff.

But that, of course, might be the point. Restructuring buybacks are common enough in Latin American and African states — and this old paper from the Inter-American Development Bank makes a point of interest to EFSF-watchers today:

Whenever a country buys its debt back (repurchase or swap), it pays the ex-post value for this debt. If the ex-post price of the bonds repurchased is higher than the ex-ante price, bond holders might appropriate a large part (possibly more than 100%) of the value generated. (For example, the price of short-term bonds tends to increase when retiring short term debt to avoid a liquidity crisis)…

…countries gain with a buyback as long as the resources used for the buyback diminish future available resources.

In other words, convince the market that you’ll be less able to pay off debt in the future, so holders may as well sell now. As the paper adds:

However, apart from the issue of appropriability, countries considering debt restructuring usually do not have resources to buyback their debts (almost by definition). An alternative option is to use loans from official lenders for the buyback, which will diminish future available resources because these debts are senior.

The problem is — are EFSF loans legally senior?

That, at any rate, appears to be the effect of funding the buyback via EFSF lending, which would effectively become senior.

It’s one weird way to do a Greek restructuring, but it’s feasible. But exactly how much could be bought back, and how would it affect the sustainability of Greek debt overall?

More on that soon.

Related links:
Et in Arcadia ego – FT Alphaville
Debt buybacks – Irish Economy
First you get the money, then you do the restructuring – FT Alphaville

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