Ratings agency Standard & Poor’s stated the obvious on Monday – that the carefully crafted bailout plan for Greece is tantamount to default because the ‘voluntary’ participation of French and German banks would reduce the value of their holdings in Greek debt.
Today, rival rating agency Moody’s warned that banks with exposure to Greek debt may be forced to take an impairment charge on their holdings if the proposed bailout is executed. Moody’s did not specifically warn, however, that the bail out would put Greece in default.
The plan was issued on June 24 by the Federation Bancaire Francaise. It has the support of EU finance ministers who met during a conference call on July 2 to approve the release of the fifth installment of last year’s 110 billion euro bailout for Greece, and to start planning for a second bailout. Policymakers and lenders agreed to the plan after the Greek Parliament defied violent street protests on June 28 and June 29 to approve 28 billion euros worth of spending cuts and 50 billion euros worth of public asset sales by 2015, including 5 billion euros worth of sales this year.
The IMF is expected to approve the issuance of the latest bailout tranche on July 8, and the funds are expected to be turned over to Greece on the 15th.
The S&P statement throws the entire plan into question, because the European Central Bank has been adamant in its view that Greek notes won’t be acceptable as collateral if they are in default. And Greece needs liquidity from the ECB. The ‘voluntary’ participation of French and German banks was supposed to avoid a default. The plan includes two options: the banks can rollover 70 percent of their proceeds into new 30-year bonds or 90 percent of their proceeds into new five-year bonds. In either case, there would be restrictions on transfer of the debt.
“In brief, it is our view that each of the two financing options described in the FBF proposal would likely amount to a default under our criteria,” the agency said in a statement issued in London. US markets were closed on Monday for the Fourth of July holiday.
S&P said the carefully crafted plan was essentially an exchange or similar transactions because Greece’s debt is in distress and lenders would take a haircut. Also, borrowers in distress usually can’t access the market for 30-year debt. In essence, the agency said if it smells like default, it’s default.
S&P’s warning doesn’t mean the bailout is dead. But policymakers and bankers will have to work quickly to develop a new structure that is more acceptable to the ratings agency, which appears to be working to rebuild its reputation after the financial crisis. Critics says the credit rating agencies were too lax in their view of structured finance products that lost value, sparking a credit crisis.
S&P appears to have left the door open for more talks on the structure of a bailout for Greece. ”We understand that the FBF proposal may change, and it is possible that it could take a form that results in a different rating outcome,” S&P said.
But it warned that the underlying crisis in the finances of Greece remains a major source of worry. “Regardless of whether the current FBF proposal is implemented, however, we continue to believe the Hellenic Republic’s uncertain ability to implement the revised EU/IMF program is a key risk weighing on its credit standing,” it said.
The euro likely will be under pressure for a few weeks, as negotiators head back to the table. The euro rose to $1.4550, its highest level in a month, early on Monday as the market digested news of Saturday’s conference call for European finance ministers. But it dropped back down to $1.4510 later in the day as S&P made it known that it viewed the “voluntary” participation of Greece’s lenders in the bailout as a form of default.
The S&P decision strengthens the hand of the ECB, which is locked on battle with the IMF and the EU over a plan for Greece. The ECB, fearful that a lenient approach to Greece will encourage fiscally troubled nations such as Portugal and Ireland to demand similar terms, has taken a much harder line. The EU has argued that taking a hard line on Greece will push the country deeper into recession, slowing economic recovery and making default all the more likely.
The increased pressure is bearing down on the EU. While the organization is likely to emerge with major changes, they could follow one of several divergent paths. Greece and other troubled nations could drop out of the eurozone and revert to national currencies. That those currencies would lose value, boosting inflation and making it even harder to repay debts.
On the other hand, the EU members could be forced ever closer together, creating fiscal links that offer enhanced security but less sovereignty for member states.
