The Eurozone leaders reached an agreement to address Greece's debt crisis with a 50% nominal write-down of Greek debt held by private creditors, preferential refinancing of the remaining debt, and closer supervision of Greece's adherence to reforms. However, the agreement lacks many important details and only kicks the can down the road by failing to adequately address the underlying issues preventing Greece's economic growth. While providing short-term relief, the measures will not be enough to solve the region's sovereign debt problems in the long run. The agreement benefits China the most as a large holder of European debt.

1. http://marketsandbeyond.blogspot.com/
http://www.pcgwm.com/
Euro summit: kicking the can down the road once more
1. The agreement
As for a well written movie script, the 4 am press conference concluded weeks of
discussions, haggling and wrangling about this Greek drama. Like the other 10 or so
summits about the eurozone crisis, this is meant to be the final shock and awe response to
years of denial, the ground-breaking decisions.
The agreement can be summarized as follows:
• Nominal write-down of 50% (EUR 100bn) of Greek debt in private
hands; Greek debt owned by official lenders not touched (so the ECB will not need
to be recapitalized)
• Remaining Greek debt will be refinanced at preferential rates
• Bond swap to be done by end-January 2012
• Closer supervision of Greek adherence to the program
• EFSF to be levered 4-5 times
• No ECB involvement in EFSF
• President Sarkozy will speak with China on EFSF
• EFSF will have both a direct insurance and SPV element; looking for
EM/IMF support for the SPV
• Estimates of EFSF firepower ranged from EUR1.0-1.4 tn
• Italy to deliver specific budget
• Banks will raise EUR 106 billion of Core Tier 1 capital by the end of 2012
to reach a 9% capital ratio (plus an additional EUR40 bn capital buffer)
Thursday, market reaction was enthusiastic with bank stocks gaining double digit
(Crédit Agricole up 23%!) and the EUR jumping 2% vs. the USD. This looks however more
like a relief of not being dead than anything really of substance so far since there is a lack
of detail and a lack of surprise. Today’s (Friday) Italian bonds yields are reaching 6% again
and French bond spreads to Bund are widening close to 1%.
Finance Ministers will decide details in November: as always the devil is in the details.
1

2. http://marketsandbeyond.blogspot.com/
http://www.pcgwm.com/
2. Analysis
• The 50% haircut the private sector will “voluntary” write-down represents EUR
100 bn (EUR350 bn - EUR70 bn Troika loans - EUR75 bn held by the ECB)*50%:
this pushes the debt/GDP ratio down to 120%.
• The press release indicates: “…with an objective of reaching 120% [the debt/GDP
ratio] in 2020”. So, if I correctly read this section of the press release and based on
September IMF numbers, it means that the Greek situation will not improve for the
10 coming years or so at double the Maastricht Treaty criteria and back to where the
ratio was in 2009. In addition, I doubt that structural reforms, if really
2

3. http://marketsandbeyond.blogspot.com/
http://www.pcgwm.com/
implemented, will produce results before years to come and a GDP decline is to be
expected for the next 1-3 years in the absence of currency devaluation.
Finally, according to IMF projections, and nothing beyond the EUR 100 bn
forgiveness has changed, the debt/GDP would reach 143% in 2012.
• Investors could question the quality of the EFSF guarantees (which only
apply in case of default) since the ISDA declared that the 50% haircut being
“voluntarily” gun-to-my-head does not constitute a credit event therefore a default.
The same thinking could apply in the future to the guarantees provided by the EFSF
on bond purchased from Greece (or other Eurozone countries). In addition:
o Since it is meant to be voluntary, some could choose not to exchange their
current holdings for new bonds weakening this frail restructuring if
numerous enough
o No detail on how it would be structured: maturity of new bonds, interest
rate, guarantees if any, ruling law, to name a few
o Other EZ countries could give up and ask part of their debt to be forgiven
• Despite the EUR100 bn debt default, this is not going to have much impact
on the Greek budget: for over a year, Greece has not borrowed on capital
markets but with the Troika and short term T bills at c. 5% and not at secondary
market rates of 20%+.
Saving: EUR106 bn*5% = EUR5 bn i.e. +/- 25 % of current interest payments or 2%
of GDP.
This will leave the country with a negative primary budget running at
about EUR1.5 bn/month or 30% of state’s revenues.
• All this is gaining some time, but does not address the issue of the lack of
state cash flows generated by the absence of growth, a weak central
state and a large black as well as uncompetitive economy.
• EUR106 bn of new core capital will not be enough if other Latin European
sovereign debt is marked-to-markets (just think Italy).
All this edifice also assumes no AAA downgrade for France, which I do not believe: France
does not deserve a AAA rating.
Conclusion
This week’s measures bring some short-term relief but are far from being the shock and
awe required and is short in details: European leaders once again kicked the can
down the road, farther this time, I admit.
3

4. http://marketsandbeyond.blogspot.com/
http://www.pcgwm.com/
The winner is China that will have a strong hand with Europe while protecting its
largest market from collapse as well as its EUR 600 bn of European debt.
As a side comment, European leader were prompt (and rightly) to name and shame
leverage as the culprit of the financial crisis and are doing the same with the EFSF.
Source:
European Union: Euro summit statement
http://consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/125644.pdf
European Banking Authority: Capital buffers for addressing market concerns over
sovereign exposures
http://www.eba.europa.eu/cebs/media/aboutus/News%20and%20Communications/Sov
ereign-capital-shortfall_Methodology-FINAL.pdf
European Banking Authority: The EBA details the EU measures to restore confidence in
the banking sector
http://www.eba.europa.eu/News--Communications/Year/2011/The-EBA-details-the-EU-
measures-to-restore-confide.aspx
4