I admit it: I've grown cynical about EU deals. They make a deal, the market rejoices, and then everyone notices that they still aren't an optimal currency union, and they haven't done many of the things that would help ease those tensions, like deepening fiscal integration. Nor have they credibly guaranteed all of each other's debt. At which point spreads begin to rise again on the debt of the shaky countries, and there we are again, watching Europe go through the motions of making yet another deal.
Well, here we are. And my trepidation has been rather neatly summed up by some sardonic headline writer at the FT. "EU reaches agreement on Greek bonds," it reads. "Officials believe deal could cut Athens' debt to 120% of GDP." This is hardly the sort of news to make one grab the pan pipes and go dancing through the Mediterranean hills.
Here are the broad outlines, as I understand them:
- Banks take a voluntary haircut on their Greek debt of 50%, in exchange for some unspecified "sweeteners". This is maybe better than what they'd get if the Greeks just defaulted, but--critically from the point of view of regulators--seems to avoid a "Credit event" that would trigger Greek CDS. This is supposed to help keep borrowing costs low, though the benefits are hotly contested.
- The €440 billion stabilization fund gets much bigger, apparently well north of €1 trillion. This adds considerable credibility to the guarantees, though it doesn't necessarily solve the problem that a lot of analysts have been worried about: every time another country runs into trouble, the pool of guarantors gets smaller, and the liabilities go up.
- The shakiest banks get a capital boost with, in total, about €100 billion going into their capital buffers. It's not clear, however, where this money is coming from
- Greece has to give a little bit back--they have to put €15 billion into the stabilization fund. Though the FT is skeptical: "Under the terms of the deal, Greece agreed to put €15bn it aims to raise from a vast privatisation programme back into the European Financial Stability Facility, the eurozone's €440bn rescue fund. International monitors have already acknowledged that Greece will struggle to raise the €50bn in privatisation cash it promised earlier this year, but the €15bn is supposed to come on top of previous commitments."
The good in this plan: it manages the impact of the long-inevitable Greek default on bank balance sheets; it boosts the credibility of the mutual guarantees. Presumably this is why the equity markets are ecstatic.
The bad: as a bond trader in my twitter feed noted "this deal seems like me telling my boss to give me my bonus now because I promise to do reaaalllly good next year." 120% of GDP is still a lot of debt--right on the edge of what most economies can reasonably support and still grow.
Yet Greece remains shackled to a huge currency zone that will not be setting monetary policy according to the needs of one small nation on its periphery. Labor mobility, which could ease the burden, will be limited by close family ties, and the fact that no one else speaks Greek. The political consensus in favor of the necessary austerity remains weak. And the euro makes their main industries--tourism and agricultural exports--more expensive than they used to be, which is going to be a drag on growth.
Without growth, attaining, maintaining, and ultimately shrinking that debt-to-GDP ratio is going to be very, very tough. Nor are they the only ones who used to rely on serial devaluation to boost the competitiveness of their tourism and small family-owned businesses; Italy, for one, was notorious for it.
That's probably why, at least as of early this morning, the bond market wasn't as optimistic as stock traders; at 7:39 am, that same bond trader tweeted "Italy 10yr 11 basis points better. Bond market isn't nearly as euphoric as equity futures." I expect that that will improve for a bit. But I very much fear that it will not last.