How the private sector could rescue Greece

There is one obvious solution to the bail-out paralysis

facing Greece, and it is gaining traction. The debt buyback. But, as with anything euro-related, striking an
agreement is proving more troublesome than navigating a
path between Scylla and Charybdis.

Greece certainly can't borrow in the markets at a rate that would make buybacks
workable. Photo: Reuters

By Philip Aldrick, Economics Editor

7:33PM BST 06 Jul 2011
2 Comments
Negotiations on a second Greek bail-out hinge on one key detail the involvement of the
private sector. Complicating matters, though, Greece can not be seen to default. Debt
restructuring has to be voluntary so the euro can preserve its fig-leaf of respectability in
the bond markets. So far, though, none of the proposals comply with both conditions.
The problem is that the ratings agencies keep scuppering Europes plans. First Germanys
proposed bond swap was dropped after ratings agencies said it would be termed a default.
Then Frances clever-clever proposal for a reprofiling of the debt met with the same
treatment.

As Ive written before, a debt buy-back, though, is still viable and would work as follows. A
borrower owes a creditor 100, say, but is in dire financial straits. The markets, recognising
that the borrower will probably never make good their debt, price the 100 loan at, say, 50.
In other words, the creditor could sell the debt in the secondary market at 50.
Obviously, the creditor may not want to sell. But even if they dont, accounting rules mean
that they may have to write off 50 to mark the debt to market. In other words, the creditor
may be forced to declare a loss. In that instance, an offer to buy the debt at 60 could prove
attractive to the creditor.
In the case of a debt buy-back, it is the original borrower that buys the debt in doing so
effectively cancelling 40 of the loan in the example above.
Of course, the complication is how to buy the debt back if you have no money. For Greece,
there is a potential solution. The European Financial Stability Facility (EFSF), Europes
440bn rescue fund.
In principle, the EFSF could buy the debt in the secondary market and cancel a large part of
it. By charging Greece an affordable rate of 5pc-6pc for use of the EFSF, Greece could
effectively shake off a large portion of its debt burden while still being able to afford its
interest payments.
The structure was tried and tested during the financial crisis when a number of banks did just
that to help repair their balance sheets.
Looking at Greeces debt profile, there is a lot to be said for the plan. Greeces 340bn of
debt is trading at about 50pc of face value, though the markdowns are smaller for short-dated
bonds and larger for longer-term debt.
Of that, about 90bn is held by foreign institutions, according to analysis of Bank for
International Settlements data by Fathom Consulting. Some 40bn of that is held by foreign
banks. Another 50bn is held by domestic Greek banks.
Analysis by Barclays Capital showed that banks have had to take writedowns on as much as
40pc of their Greek sovereign debt holdings. Figures released alongside last years European
stress tests revealed that about a quarter of all Greek debt owned by the banks was held on
their trading books, which must be marked to market.
BarCap estimated that as much as 15pc more was held as available for sale, which also has
to be marked to market for regulatory purposes against capital though the losses do not pass
through to profits.
As a result, banks have effectively already absorbed a significant hit from the crisis.
Extrapolating from the data, foreign and domestic banks may have taken marks on 36bn of
Greek debt already. If the debt was bought back at 60pc of face value, some 14bn would be
cleared in one fell swoop. And thats assuming other foreign institutions such as pension
funds dont participate at all. If the same numbers applied to them, Greece could potentially
clear another 8bn of debt.
Best of all, it would all be voluntary.

The private sector is on board for this plan. Charles Dallara, managing director of the
Institute of International Finance (IIF), which represents more than 400 of the worlds biggest
banks and insurers and is leading talks about creditor participation, said: Were going to
discuss a range of options, including variations on the original French proposal as well as
options relating to buy-backs.
In an official statement, the IIF said: It would be important to consider possible debt buyback proposals, which could, along with further fiscal adjustment, begin to reduce the stock
of debt and help pave the way toward improved debt sustainability.
Indicating just how significant this could be, Mr Dallara told Bloomberg that a buy-back fund
of about 50bn, for example, could reduce Greeces outstanding debt as a proportion of GDP
by as much as 20pc.
There is, of course, a catch. Jean-Claude Trichet, the European Central Bank president, has
been arguing that buy-backs be conducted through the EFSF since February. He has been
given short shrift. In March, European authorities ruled out using the facility for buy-backs.
Its statutes could still be changed, but unless they are, there is no obvious body that could
conduct buy-backs on the scale required. Greece certainly cant borrow in the markets at a
rate that would make it workable.
So, until then, Europe continues to find itself stuck between a rock and a hard place.