Friday, 22 July 2011

Greece -- is defaulting on its debt, as its bond investors are being asked to swap their securities for new ones with less appealing terms.

For Europe, the unthinkable now is reality: A euro zone country -- Greece -- is defaulting on its debt, as its bond investors are being asked to swap their securities for new ones with less appealing terms.

The idea is to reduce the country’s crushing debt burden and give it time to mend its wounded economy. Turn in your Greek bond that matures in two years, for example, and get one that won't mature for 30 years.

Defaults are supposed to happen in Third World countries, not to a nation in the euro zone. It shows how the world has been turned upside down since the 2008 financial crash exposed the severe debt levels of many developed nations.

The credit rating firms haven’t yet ruled on the details of the European Union’s second bailout of Greece, announced Thursday. But it’s widely expected that, under the plan, Greece will be declared in “selective default” on its nearly $500 billion in debt, meaning that some investors will take losses while others may be paid in full.

As part of the EU’s program to lend another $157 billion to Greece to help it cover its debts, the Continent’s leaders want private bondholders to voluntarily share in the cost of rescuing the nation from fiscal ruin.

Reuters’ Felix Salmon nicely delineated the choices faced by Greek bondholders:

-- Do nothing, and hope that Greece pays you in full and on time.

-- Turn in your bonds for a new 30-year bond and accept a modest annual interest return of 4.5%. Your principal would be guaranteed with an embedded zero-coupon bond (i.e., one that pays all of its interest at maturity) from a triple-A-rated EU institution, probably the European Financial Stability Facility rescue fund.

-- Turn in your bonds for a new 30-year bond but take a 20% haircut on your principal. In return you’d  be paid an annual interest return of 6.42%; again, the remaining principal would be guaranteed with zero-coupon collateral.

-- Turn in your bonds for a new 15-year bond, take a 20% haircut on your principal, earn an annual interest return of 5.9%, and get only a partial principal guarantee through funds held in an escrow account.

It remains to be seen how investors will react, although some of Europe’s biggest banks and insurers, which own massive amounts of bonds of Greece and other euro-zone governments, signaled their support for the plan Thursday. Those institutions include German insurer Allianz, French bank Societe Generale and National Bank of Greece.

More important will be what happens in the bond markets of Europe’s other financially challenged states -- Portugal, Ireland, Spain and Italy. In recent weeks, investors had been demanding ever-higher market yields on those countries’ bonds, meaning the securities’ values were tumbling as the Greek debt “contagion” spread.

Those yields began to ease this week ahead of the EU summit Thursday on Greece. The yield on two-year Irish bonds (charted at left) fell to 19.1% on Thursday (before the Greek plan was announced) from 21.8% on Wednesday and 23.2% on Monday.

Italy’s two-year bond yield fell to 3.62% from 3.98% on Wednesday and 4.57% on Monday.

The EU plan for Greece also includes new financial aid for Ireland and Portugal and back-up credit lines for Spain and Italy. The EU’s intent is to show bond investors that the Continent is throwing its full financial support behind its troubled member states, hoping to allay fears about owning the countries’ debt. In theory, that should drive market interest rates down, lowering the risk of a wider crisis.

But as Reuters’ Salmon noted, there’s another way for investors to interpret the latest bailout:

Overall, this looks like a deal which can quite easily be scaled up and used as a framework for future default/restructurings. I don’t know if that’s the intent. But there’s nothing here to reassure holders of Portuguese and Irish bonds -- or even Spanish and Italian bonds, for that matter -- that they’re home safe. Greece will be the first EU country to default on its debt. But I doubt it’ll be the last.

Sunday, 3 July 2011

Fans of Tony Blair and Peter Mandelson, who mourn their departure from the political frontline, will be dancing with joy.


Two of the founding fathers of New Labour could make a spectacular comeback on the world stage in the next few years. I reported last month that David Cameron is prepared to back Mandelson as the next director general of the World Trade Organisation, raising the prospect of a fourth comeback by the former Prince of Darkness.

One senior diplomatic source said that Downing Street is deadly serious about lining up Britain's former European trade commissioner for one of two posts:

• The next director general of the WTO after the Frenchman Pascal Lamy stands down next year. Britain believes France will support a British candidate after George Osborne provided early – and decisive – backing for Christine Lagarde as the managing director of the IMF.

• The EU's high representative for foreign affairs if Baroness Ashton decides to throw in the towel before her term ends in 2014. Ministers, who are supportive of Ashton in public, believe she is struggling. They would not be surprised if she stands down. Mandelson had wanted the job in 2009 and believes Gordon Brown let him down by failing to back him.

This is what the diplomatic source told me about Mandelson:

Of all the figures associated with New Labour Peter Mandelson is the one figure who is on Downing Street's radar. David Cameron and George Osborne are serious about finding him a big job. The WTO post is coming up. But Peter Mandelson would be an obvious candidate to succeed Cathy Ashton if she stands down. Ministers accept that that post would have to go to a Labour candidate between now and 2014 because of the deal with the European Parliament in 2009 [over top EU jobs] when Cathy and Herman Van Rompuy, [centre right president of the European Council], were appointed.

If Mandelson lands a job he may be greeted by familiar face on the world stage. The thought is slowly dawning on ministers and officials that Tony Blair may be the ideal candidate to succeed José Manuel Barroso as president of the European Commission when he retires after two terms in 2014.

This would be a more modest post than the job Blair recently floated. In an interview with the Times to promote the latest volume of his memoirs, the former prime minister said that the EU needs a directly elected president to give the union greater clout on the world stage.

The president of the European Commission is appointed by the heads of government of all 27 EU member states. Barroso often lives in fear of large member states, particularly France.

Whitehall sources say that it is early days and Blair's chances may depend on the outcome of next year's French presidential elections. Nicolas Sarkozy, the French president, would be a strong candidate to succeed Barroso if he loses the presidential election next year. Angela Merkel, the German chancellor, may also like to become the first German president of the commission since Walter Hallstein in 1967.

Blair may also feel that he has had his fill of high European politics. He had hoped to become the first president of the European Council in 2009. But his campaign fell apart when José Luis Zapatero, the Spanish prime minister, vetoed Blair in private. Zapatero will stand down at the next election in Spain.

If Blair enters the frame he will have certain advantages. Unlike Barroso, who hails from a relatively small member state (Portugal) and who was a centre right prime minister, Blair is from one of the "big three" member states and was (if only on paper) a centre left prime minister.

But Blair would have one key disadvantage at a time when the single currency is struggling: Britain is not a member of the euro. But Blair could argue that at least he tried on that front while he was prime minister.

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