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The Debt Crisis in the European Union

The Great Greek Bond Bazaar

by Éric Toussaint

In July-September 2011 the stock markets were again shaken at international level. The crisis has become deeper in the EU, particularly with respect to debts. The CADTM  interviewed Eric Toussaint about various facets of this new stage in the crisis.   

CADTM:  You say that since the crisis broke out in May 2010 Greece has stopped issuing 10-year bonds. Why then do markets demand a yield of 15% or more on Greece’s 10-year bonds? [1]

Eric Toussaint: This has an influence on the sale price of older Greek debt bonds exchanged on the secondary market or on the OTC market.

There is another much more important consequence, namely that it forces Greece to make a choice between two alternatives:

a)  either depend even further on the Troika (IMF, ECB, EC) to get long-term loans (10-15-30 years) and submit to their conditions;

b)  or refuse the diktats of markets and of the Troika and suspend payment while starting an audit in order to repudiate the illegitimate part of its debt.

CADTM: Before we look at these alternatives, can you explain what the secondary market is?

Eric Toussaint: As it the case for used cars, there is a second-hand market for debts. Institutional investors and hedge funds buy or sell used bonds on the secondary market or on the OTC (over the counter) market. Institutional investors are by far the main actors.

The last time Greece issued ten-year bonds was on 11 March 2010, before speculative attacks started and the Troika intervened. In March 2010, to get 5 billion euros, it committed itself to an interest rate of 6.25% every year until 2020. By that date it will have to repay the borrowed capital. Since then, as we have seen, it no longer borrows for ten years because rates blew up. When we read that the ten-year interest rate is 14.86% (on 8 August 2011 when the 10-year Greek rate, which had been as high as 18%, was again below 15% after the ECB’s intervention), this indicates the price at which ten-year bonds are exchanged on the secondary or OTC markets.

Institutional investors who bought those bonds in March 2010 are trying to sell them off on the debt secondary market because they have become high risk bonds, given the possibility that Greece may not be able to refund their value when they reach maturity.

CADTM: Can you explain how the second-hand price of the ten-year bonds issued by Greece is determined?

Eric Toussaint: The following table should help us understand what is meant by saying that the Greek rate for ten years amounts to 14.86%. Let us take an example: a bank bought Greek bonds in March 2010 for EUR 500 million, with each bond representing 1,000 euros. The bank will cash EUR 62.5 each year (i.e. 6.25% of EUR1,000) for each bond. In security market lingo, a bond will yield a EUR 62.5 coupon. In 2011 those bonds are regarded as risky since it is by no means certain that by 2020 Greece will be able to repay the borrowed capital. So the banks that have many Greek bonds, such as BNP Paribas (that still had EUR 5 billion in July 2011), Dexia (3.5 billion), Commerzbank (3 billion), Generali (3 billion), Société Générale (2.7 billion), Royal Bank of Scotland, Allianz or Greek banks, now sell their bonds on the secondary market because they have junk or toxic bonds in their balance sheets. In order to reassure their shareholders (and to prevent them from selling their shares), their clients (and to prevent them from withdrawing their savings) and European authorities, they must get rid of as many Greek bonds as they can, after having gobbled them up until March 2010. What price can they sell them for? This is where the 14.86% rate plays a part. Hedge funds and other vulture funds that are ready to buy Greek bonds issued in March 2010 want a yield of 14.86%. If they buy bonds that yield EUR 62.5, this amount must represent 14.86% of the purchasing price, so the bonds are sold for only EUR 420.50.

  Nominal value of a 10-year bond issued by Greece on 11 March 2010 Interest rate on 11 March 2010 Value of the coupon paid each year to the owner of a EUR1,000 bond Price of the bond on the secondary market on 8 August 2011

 

Actual yield on 8 August 2011 if the buyer bought a EUR 1,000 bond for EUR 420.50
Example

EUR 1,000

6,25%

EUR 62,5

EUR 420,50

14,86%

To sum up: buyers will not pay more than EUR 420.50 for a EUR 1,000 bond if they want to receive an actual interest rate of 14.86%. As you can imagine, bankers are not too willing to sell at such a loss.

CADTM: You say that institutional investors sell Greek bonds. Do you have any idea on what scale?

Eric Toussaint: As they tried to minimize the risks they took, French banks reduced their Greek exposure by 44% (from USD 27 billion to USD 15 billion) in 2010. German banks proceeded similarly: their direct exposure decreased by 60% between May 2010 and February 2011 (from EUR 16 to EUR 10 billion). In 2011 this withdrawal movement has become even more noticeable.

CADTM: What does the ECB do in this respect?

Eric Toussaint: The ECB is entirely devoted to serving the bankers’ interests.

CADTM: But how?

Eric Toussaint: Through buying Greek bonds itself on the secondary market. The ECB buys from the private banks that wish to get rid of securities backed on the Greek debt with a valuation haircut of about 20%. It pays approximately EUR 800 for a bond whose value was EUR 1,000€ when issued. Now, as appears from the table above, these bonds are valued at much less on the secondary market or on the OTC market. You can easily imagine why the banks appreciate being paid EUR 800 by the ECB rather the market price. This being said, it is another example of the huge gap between the actual practices of private bankers and European leaders on the one hand and their discourse on the need to allow market forces to determine prices on the other.

Éric Toussaint, doctor in political sciences (University of Liège and University of Paris 8), president of CADTM Belgium, member of the president’s commission for auditing the debt in Ecuador (CAIC), member of the scientific council of ATTAC France, coauthor of “La Dette ou la Vie”, Aden-CADTM, 2011, contributor to ATTAC’s book “Le piège de la dette publique. Comment s’en sortir”, published by Les liens qui libèrent, Paris, 2011.

Translated by Christine Pagnoulle and Vicki Briault in collaboration with Judith Harris

Notes.

[1] On 25 August 2011 the Greek rate for 10 years reached 18.55%, on the day before, 17.9%. The rate for 2 years was a staggering 45.9%. http://www.lemonde.fr/europe/article/2011/08/25/les-taux-des-obligations-grecques-a-dix-ans-atteignent-un-nouveau-record_1563605_3214.html (accessed 26 August 2011)