Yesterday just as I had finished my article on Greece and her debt problems I took a look at the news services and saw that she was planning an issue of a new seven-year bond. For the reasons I stated yesterday I think that is too long a term and yes I am aware that as a longer-term debt management objective it would help Greece if she lengthened the average maturity of its debt. Doing so now is both unnecessarily masochistic and expensive in my view. This is because her shorter-dated bond maturities are cheaper to issue at than her longer dated ones mostly because of the change in the collateral rules at the European Central Bank (ECB) where Greek government debt will be accepted now in return for loans after the end of this year. I think Steve Winwood got it right in one of his songs “While you see a chance take it…”
Since Greece’s last bond issue we have had two main events.
1. An extension of her austerity programme with around another 2% of Gross Domestic Product (GDP) added to the existing plans.
2. The rescue plan from the Euro zone announced last week.
The result of these? Greece ended up issuing guidance on the same terms that she had for her ten-year government bond issue which came out on March 4th 2010. The guidance price was exactly the same being the mid-swaps price plus 310 basis points. So apart from a slight variance because it was seven-year swaps and not ten-year swaps there is no difference. Greece’s Finance Minister had been quoted on March 16 in the Wall Street Journal
“It’s clear that we are not happy to be paying the kind of mark-ups and spreads that we’re paying at the moment,” he said. “But as we have stated all along it’s a question of rebuilding credibility and it’s very clear now that this credibility is being rebuilt”
Sadly this statement was exposed as being somewhat optimistic at best. After all otherwise the borrowing terms would have improved and of course the rescue plan from the Euro zone had also been added to the mix after his speech. The grandstanding of politicians has been exposed by market events yet again.
Was the issue a success?
On the simplest level yes it was as Greece got her 5 billion Euros and over the next two months she needs to issue debt. So the Greek government can continue to function and does not need to phone the International Monetary Fund for a while anyway.
However it came at a very high price. Having established a guidance price shown above of 310 basis points above the mid-swaps rate the bond was issued at 325 basis points over. So somewhere in the negotiations to find buyers Greece found herself having to pay more than an already high price and the coupon for the bond ended up at 5.9%. So rather than cheaper borrowing costs there is an argument that Greece has in fact had to pay slightly more.
I have taken a look at the interest rates on seven-year government debt around Europe to give a relative comparison.
Germany 2.66%, Italy 3.11%,Spain 3.27%, the UK 3.47%,Portugal 3.8%
Think of all the international promises and the austerity plan and then compare Greece’s yields with her peers, I think they remain rather eloquent…..
Greece’s other government bond yields moved higher yesterday. Her two-year bond rose by more than 0.25% to 5.48% and her ten-year rose to 6.27% leaving the spread over Germany’s ten-year bund at virtually exactly double.
Analysis and Comment
There are plainly problems with yesterdays issue. Greece will have to pay for these for the next seven years. Only the initial objective of raising some cash was achieved.
However something was revealed to me by some research from Deutsche Bank. They have looked at the foreign holdings of what they quaintly call Hellenic Republic bonds over the last five years. Over this period the foreign holdings of such debt has steadily risen. It now stands according to them at 75% of the issued stock or just under 220 billion Euros.
Now imagine a scenario where the austerity programme in Greece hits difficulty. Not that hard to imagine is it? For example there has been a report from Goldman Sachs questioning Greece’s methodology in calculating its fiscal deficit and stating that it believes it could be as high as 16% of GDP this year. So in such a difficult situation it is bound to occur to someone that if 75% of her government bonds are held by foreigners then default may not be so painful after all.
Foreign investors will I think become more and more aware of this. This factor was probably a big reason behind the change in the ECB’s collateral rules (although they would never admit it). Except even if Greek banks and individuals start to buy more of their own government debt foreign investors will remain exposed to a large sum.
In fact if Greece was to really play the game in a rather cynical fashion she could drive as hard a bargain as she can for foreign aid and help particularly from the Euro zone but also the IMF. Then after a suitable delay she could default knowing that 75% of her government bond market is held by foreigners. Put that way it may start to sound tempting…….
The Canary in the Coalmine
Over the last two weeks something rather significant has developed. It involves government bond markets and has been particularly prevalent in the UK and the US. You see over what are benchmark bond maturities it is now possible for private companies to borrow more cheaply than AAA rated governments. This began late in 2008 for the 30 year maturity in the US and was related to the crisis caused by the failure of Lehman Brothers. Now apart from people like me not many bother with looking at things like that except it has been joined by its ten-year cousin which is much more actively followed. So American ten-year US Treasury Bonds now yield more than the ten-year swap rate and what is now called the swaps rate is therefore negative.
Now there are market disturbances which may be influencing this, for example the US Federal Reserve stops buying mortgage-backed securities today and financial markets are not in a “normal” state. However it could also be a harbinger of trouble ahead, remember 2007 when one or two other signals began to tell us that something was afoot? One thing is sure sovereign governments have a lot of debt to sell over the next few years.
On the subject of economics it also poses a question as many economic models rely on a “risk-free” interest rate. This would normally be considered to be US Treasury yields but currently due to the events described above it cannot be. As I have written many times before slavish adherence to economic models in this time of economic disruption is tantamount to foolishness in my view. The “risk-free” interest rate was always an illusion but some still prefer illusions to the real world.
Chancellors Debate and UK GDP figures
Whilst an innovation and well done to Channel 4 for showing it, we actually learnt very little. The most respected of the 3 prospective Chancellors before and after the programme was/is probably Vince Cable. As to the very real difficulties the UK will face going forward there was very little real debate which is a shame. It has happened before that economic issues have got submerged in an election campaign,1992 for example, but it is not good.
I see that todays UK GDP figures are being reported incorrectly in some places so I thought that I would quote from the Office of National Statistics to put this right as the figures in fact show us coming slightly more quickly out of a recession which was deeper then previously thought. As time goes by these numbers will probably be revised further.
The movement in GDP in 2009 quarter four has been revised up to show a rise of 0.4 per cent from a rise of 0.3 per cent. The second quarter of 2009 has been revised down to show a fall of 0.7 per cent, from a fall of 0.6 per cent.