Greek debt deal: Many questions remain

Wednesday’s announcement that a deal had been reached by the European Union members does not end the debt crisis. At best, some immediate uncertainty has been addressed. But without more information on the details, including how the announced actions will be implemented and, most importantly, who will actually pay for them, the crisis is far from solved.

Nevertheless, the markets clearly approved the Greek debt deal and stock prices have risen sharply. At this point, investors are eager to latch on to even the slimmest glimmer of hope that legislators have finally set the eurozone in the right direction. Have they?

A key element of the debt deal centers on the treatment of Greek debt held by private investors. The European banking system agreed to take a “voluntary” 50 percent write down. This action alone will save Greece more than $140 billion as this debt matures.

But, of course, there was nothing voluntary about this at all, and investors had little choice but to accept the write down. Describing the revaluation in this manner is simply a clumsy attempt to avoid the triggering of a credit event, which would result in Greece receiving a default status from the ratings agencies.

In reality, the percentage of the write down was one of the sticking points threatening to scupper the deal right up until the final hours of the summit meeting.

Knowing that they could not escape without suffering some measure of loss, the banks initially suggested that 21 percent was a reasonable write down. The leaders of the eurozone felt 60 percent was more appropriate. The banks then upped their offer earlier this week to 40 percent, ultimately paving the way to a compromise of a 50 percent write down. No doubt, some serious arm-twisting went on behind the scenes to secure the banks’ cooperation.

Even so, some commentators suggest that cutting Greece’s outstanding debt in half will still prove insufficient to prevent a default. Even with this revaluation, the ratio of Greece’s debt to its gross domestic product remains well above 100 percent, a risky level by historical standards.

On a more positive note, the International Monetary Fund approved the next payment of the original bailout it offered to Greece. This adds another €2.2 billion ($3.1 billion) to the €5.8 billion ($5.1 billion) already released by the eurozone members last week and should ensure that Greece can keep the lights on for at least another month.

The European Financial Stability Fund (EFSF) was created to pool resources that could then be used to purchase debt from sovereign countries to ensure a steady stream of revenue at an affordable rate. It was clear something was needed after the early stages of the Greek crisis when Greece found it virtually impossible to sell its debt issues on the open market except at punishingly high interest rates.

The latest deal calls for the value of the EFSF to be increased to €1 trillion ($1.4 trillion). Here’s the trick though, the fund only has about €440 billion in cash, with another €800 billion or so in “guarantees” backed by the European Union, at its disposal. Even this total would not be enough to prop-up a larger economy like Italy or even Spain. Therefore, the plan is to “leverage” the cash already held in the EFSF to increase the potential value of the fund.

This is where things get a little muddled.

For example, if a country – oh, let’s say, Italy – needs €300 billion in an emergency, it would be made available. But only a portion of the money would actually come from the EFSF. The rest would be provided by private investors “buying” into the fund itself. In other words, investors could contribute to the EFSF, where their investment would earn interest while being guaranteed by the collective of EU member nations.

The term “ponzi” might be a little strong to describe this arrangement, but from here, it appears that all the risk has simply been shifted from the investor to the taxpayer.

– Scott Boyd is a currency analyst with OANDA, a Forex trading company with offices in New York,Toronto, Singapore, and Dubai, and contributes to the company’s MarketPulse FX blog.