Compromise to Nowhere; Germany Mulls Greek Debt Buyback; More Haircuts Coming?

Late last week, following a bitter feud between German Chancellor Angela Merkel and French President Francois Hollande, a compromise of sorts was reached at the latest summit.

Please consider Berlin and Paris Compromise on Bank Oversight.

European leaders have reached agreement on the roadmap to a banking oversight regime in the euro zone. Following a public back-and-forth between German Chancellor Angela Merkel and French President François Hollande, the 27 European Union heads of state and government on Thursday night found a compromise at their two-day summit in Brussels.

The agreement calls for the legal framework for financial sector oversight to be completed by the end of the year, but actual implementation won't come until later. The oversight regime will be introduced "in the course of 2013," the summit's closing statement reads.

The compromise is a victory for Merkel. Both France and Spain had been emphatic that bank oversight begin on Jan. 1, 2013. Berlin, however, insisted that any such regime be thoroughly planned and resisted efforts to move quickly, receiving support from such non-euro-zone countries as Sweden and the Czech Republic. Over a dinner of roast veal and spinach, Hollande and his allies backed down.

As the week progressed, it seemed as though the conflict between Europe's most important protagonists had escalated.

The French president in particular seemed to be on the war path. He gave a joint interview to several European dailies which included what seemed to be a direct attack on the chancellor. "Those who speak most passionately about political union are often the ones who hesitate the most when it comes to making pressing decisions," he said. His feistiness did not abate immediately upon his arrival in Brussels. Before meetings began, he insisted that the summit would be focusing on the planned banking union and not on fiscal union, Merkel's preferred project. He also accused Merkel of dragging her feet on bank oversight due to the approaching 2013 general elections in Germany.

Merkel didn't shy away from confrontation either. During her speech to German parliament on Thursday prior to her departure for Brussels, she threw her support behind Finance Minister Wolfgang Schäuble's proposal, made earlier in the week, for a super commissioner to monitor, and even veto, national budgets of euro-zone member states.

Compromise to Nowhere

Bear in mind last June the Euro leaders agreed to do this by the end of this year. Now the target, minus details, "will not come until later". The oversight regime will be introduced "in the course of 2013."

Is "introduced" the same as "implemented"? The more important question is "Does it even matter".

Catch A Falling Knife

In his Weekly T-Report Peter Tchir sums up the situation nicely.

I would love to be able to say that Europe is fixed. It isn’t and this particular summit was particularly disappointing. They announced some vague plan to plan a bank supervisor. I still don’t understand why people really think a bank supervisor would change anything. Just think about the Spanish bank bailout. Money was supposed to be available in July, then August, then September and as far as I can tell, not a single distribution has been made.

Spain is not asking for a bailout yet, and allegedly it wasn’t even discussed. I cannot tell whether it would be worse if it wasn’t discussed or that they are lying to us and it was discussed but no conclusion was reached.

Talk about various ways to manipulate the Greek debt problem. Plans range from further punishing the PSI bonds which I think would meet with incredible resistance and accomplishes nothing, to ways to get the ECB off the hook and dump losses on ESM. I am not sure there is any particularly good solution to the official sector problem because owning 10′s of billions of mismarked bonds and loans is a difficult problem to overcome.

Then there is news that France is in more frequent disagreement with Germany. That will make any longer term solution more difficult to achieve.

So why didn’t markets sell-off more? At this stage everyone still believe the ECB will intervene with OMT and the ESM will provide some form of PCL along the lines of the IMF’s programs (my ultimate goal is to write and entire paragraph with just acronyms).

One of these days, Europe will fail to catch the falling knife. Europe has let the situation deteriorate and then the EU cobbles together some sort of program that kicks the can for a little while. OMT and ESM should be the ultimate in can kicking, but every delay means that resistance will mount. If ESM gets immediately saddled with ECB GGB losses, how will the countries react? Will there be an immediate capital call? The ESM is supposed to be leveraged at 6.66 times and any losses that hit capital would limit how much it could currently borrow.

I see a likely scenario that the market starts to question the resolve of Europe and the dissent amongst all the various organizations and the countries rewards those who bet against Europe now. I would be selling Italian and Spanish bonds here or even short.

Meaningless Plans Roll On

Slowly but surely Greek bondholder losses approach 100%. There have been several haircuts already and now the German Finance Ministry Mulls Yet Another Debt Buy-Back Scheme.

Germany's Finance Ministry is considering a debt buy-back as a possible way of reducing Greece's huge debt pile which threatens to rise well above a target level of 120 percent of GDP by 2020, according to German news magazine Spiegel.

The Greek government could borrow money from the euro zone's permanent bailout fund and use this to buy back its own debt, which at present trades at around 25 percent of its face value. Buying just 10 million euros worth of Greek bonds could reduce the debt mountain by 40 million, Spiegel said.

Talks would have to take place with debt-holders to see if they would accept such a price for their Greek paper.

Ho Hum

Would bond holders agree to another haircut? Even if they did,  would it matter?

In a report earlier this week Tchir estimated a buyback would save Greece less than a billion euros a year.

His math "Greece pays 2% on these bonds and the first maturity is 2023. Other than meeting some artificial Troika target, this plan has no meaningful impact. Greece will have to borrow money from the ESM to pay for these bonds. Depending on the price they pay and the coupon on the new debt, they will likely receive cost savings of far less than €1 billion per annum. If the average price paid is 50% of par (seems likely once the deal starts) and the borrowing rate on the ESM loans is 2%, the cost savings would be €600 million."

There's your answer: no it would not matter.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com