Wednesday, 31 March 2010

Greek bond sold 30th March, political economics rules OK

Yesterday it was triumphantly announced that Greece successfully sold a €5bn, 7 year with a coupon of 5.9%. Well if you are happy to pay 3.25% more than the Germans pay for a similar tenor bond! The Greeks need €23bn by end of May so that will need another 3 offerings by then. They need €53 bn in total by end 2010 which is a bit more than one a month till year end. I hope the market has a good appetite for moussaka, there is plenty coming their way.

More interesting is the banks chosen to place the bond, a lucrative bonus enhancing process for bankers. Goldman Sachs were noticeably absent from the chosen few. French banks, especially those with Greek subsidiaries were well represented. This was seen as a reward for M Sarkozy's helpful attitude last week to the Greek problem. These banks of course did not use their own money but those of their clients French pension funds and the like from whom the bond can be borrowed by their friendly banks for a very small fee.

The real help to the Greeks came not from M Sarkozy, but as I noted in a previous blog from M Trichet, Governor of the ECB who helpfully said the ECB would continue to take Greek bonds in their open market repo operations even if these bonds were down graded by the nasty Anglo Saxon credit rating agencies. Under its own rules the ECB should not accept non-investment grade bonds as repo collateral but of course in Euroland rules can be waived to help a friend.

The FT today put it rather well today, I quote,

"Market-watchers said that last week's decision by the ECB to keep existing rules on collateral beyond 2010 was just as important as the EU package because it ended fears among investors that Greek banks would no longer be able to borrow from the ECB in exchange for Greek government bonds."

This is a hidden subsidy to the holders of Greek debt because of the steepness of their yield curve. An accredited Euroland bank with a Greek bond can use it as collateral to borrow Euros from the ECB at their policy rate, currently 1%, in their repo refinancing operations. The amount loaned should be the dirty market value of the bond less a safety margin that depends on the tenor of the bond but at 7 to 10 years would typically be 2% to 3%. When the repo ends the bank repays to the ECB the loan plus interest calculated pro rata at 1%p.a. The bank then has its bond back plus the coupon interest accrued at say 6%. So Greek bank makes almost 5% on the deal. Its a great money making exercise.

The snag is in the weasel words market value. There is not a real market in these bonds so how do you get a market value to calculate the loan amount. That is a problem some poor sod in the ECB will be sweating over right now under considerable political pressure. The risk is if the Greek government defaults on its debt when the bond's value takes a big hit. Before it gets to this stage the ECB should have called for variation margin but that depends again on having a market price - Nick Leason gave a good explanation of how this process should work in the Barings Bank film.

Who ends up with the loss? The ECB should demand the amount loaned back and if the bank cannot pay then the ECB will sell the bond for what it can get in the market, probably not a lot as they say. So we end up with bust Greek banks, an overall rise in Euroland interest rates, a fall in the Euro plus a hole in the ECB balance sheet that, yes you've guessed it, the Germans will have to fill.

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