Refinance Euro-style


Grand Bargain at last?

Big doings in Europe on the Greek debt crisis. As I read it, the new plan has three essential elements.

First, and essential, is a recognition of losses. There is to be a bond swap, risky old Greek debt for riskfree new debt of the European Financial Stability Facility. For debt holders, face values may stay the same, but maturities will be drastically extended (up to 30 years) and interest rates drastically reduced (3.5% is mentioned). More or less these same terms will then be applied to a refinancing of Greece itself by the EFSF.

Second, there is a mechanism for handling the immediate fallout of this loss recognition. Greek banks, but also French and German banks, and even the ECB will take this loss as a hit to capital, and so may need to be recapitalized. That too is to be the task of the EFSF, but with the credit risk taken by individual governments; the EFSF lends to the individual government (say France) which uses the funds to buy preferred shares in its ailing banks. This is basically TARP, Euro-style.

Third, there is a mechanism for handling the longer run fallout of the loss recognition, fallout that will play out in the market for the debt of Portugal, Ireland, and perhaps others. Again the EFSF is to be the agency, and it is empowered to use its lending authority proactively, even going so far as directly to buy sovereign debt on the secondary market.

I would think this third feature is key from the point of view of the ECB. For lack of something like the EFSF, the ECB has been more or less forced into using its own lending authority to keep the music going. Now it is going to have to take losses for doing so, which no central bank likes, but the sweetener is that in future there will be an EFSF as the first resort.

The overall bottom line is that there is to be a Europeanization of the Greek debt, and by implication also the debt of other individual European states, and this feature will be key from the point of view of the IMF. For lack of something like the EFSF, the IMF has also been more or less forced into using its own lending authority to keep the music going.

There is vague language about continuing involvement of the IMF, which to me suggests that there is unfinished business about loss recognition on that score. The more important thing, however, is that Europe is taking care of its own business. The IMF would never get involved in the debt problems of California, and now with the EFSF it will not again be called upon to get involved in the debt problems of individual European states.

For Europe, the EFSF is a step toward a Europe-wide fiscal authority, but not the whole way to an American-style Treasury. EFSF bonds are, in effect, Eurobonds but the immediate backing for them is the assets held by the EFSF not the taxing authority of any Europe-wide fiscal authority. Individual states jointly guarantee the EFSF debt, but there seems to be an attempt to ensure that the assets are low risk, so that this guarantee is backstop only.

For private holders of European peripheral debt the news is apparently good also. They are not going to get out at par, but they have a variety of options, and in all of them there is now a floor underneath the value of their bonds. Even more, and notwithstanding strong language about Greece being a one-time deal only, everyone knows that this deal is the template for any future deal elsewhere. No one is going to want to run over again the tortuous road that has finally led to the present deal.

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