EU leaders should have asked for a higher, much higher, write-off

In the morning hours of Thursday October 27 2011, EU leaders have one more time reached an agreement on how to deal with the Greek debt problem. The outcome is a 15 (fifteen) page document. But for a long document the statement offers very little details. After reading it I am convinced this is not the last time will hear about Greek debt problem or bank capitalization.

Expect markets to react positively to the news. But wait for the pull back after everyone understands the details of the statement and when they remember about the other countries in Europe with sovereign debt problems. I hoped the meeting yesterday dealt more with the EU debt sovereign issue and not only with the specific case of Greece.

Regrading Greece, the deal still leaves the country with a 120% debt to GDP ratio, still too much in my view. I do not know why they cannot just call it like it is: Greece will not be able to pay back their debt. Maybe, if we push 20% of it into the far far away future. Under the current deal Greece will still be required to go through draconian measures to receive the funds. As I said before, austerity measures do not work during crisis. I expect to talk about further debt write-offs for Greece in few months times. Hopefully we do not have to talk about write-offs for Spain or Italy until then.

These are my takes from the document, highlights are my own:
“The Private Sector Involvement (PSI) has a vital role in establishing the sustainability of the
Greek debt. Therefore we welcome the current discussion between Greece and its private
investors to find a solution for a deeper PSI. Together with an ambitious reform programme
for the Greek economy, the PSI should secure the decline of the Greek debt to GDP ratio with
an objective of reaching 120% by 2020. To this end we invite Greece, private investors and
all parties concerned to develop a voluntary bond exchange with a nominal discount of 50%
on notional Greek debt held by private investors. The Euro zone Member States would
contribute to the PSI package up to 30 bn euro. On that basis, the official sector stands ready
to provide additional programme financing of up to 100 bn euro until 2014, including the
required recapitalisation of Greek banks. The new programme should be agreed by the end of
2011 and the exchange of bonds should be implemented at the beginning of 2012. We call on
the IMF to continue to contribute to the financing of the new Greek programme.”

“We agree that the capacity of the extended EFSF shall be used with a view to maximizing the
available resources in the following framework:
• the objective is to support market access for euro area Member States faced with market
pressures and to ensure the proper functioning of the euro area sovereign debt market,
while fully preserving the high credit standing of the EFSF. These measures are needed
to ensure financial stability and provide sufficient ringfencing to fight contagion;
• this will be done without extending the guarantees underpinning the facility and within
the rules of the Treaty and the terms and conditions of the current framework
agreement, operating in the context of the agreed instruments, and entailing appropriate
conditionality and surveillance.”

“Capital target: There is broad agreement on requiring a significantly higher capital ratio of
9 % of the highest quality capital and after accounting for market valuation of sovereign debt
exposures, both as of 30 September 2011, to create a temporary buffer, which is justified by
the exceptional circumstances. This quantitative capital target will have to be attained by 30
June 2012, based on plans agreed with national supervisors and coordinated by EBA. This
prudent valuation would not affect the relevant financial reporting rules. National supervisory
authorities, under the auspices of the EBA, must ensure that banks’ plans to strengthen capital
do not lead to excessive deleveraging, including maintaining the credit flow to the real
economy and taking into account current exposure levels of the group including their
subsidiaries in all Member States, cognisant of the need to avoid undue pressure on credit
extension in host countries or on sovereign debt markets.”

“Financing of capital increase: Banks should first use private sources of capital, including
through restructuring and conversion of debt to equity instruments. Banks should be subject to
constraints regarding the distribution of dividends and bonus payments until the target has
been attained. If necessary, national governments should provide support , and if this support
is not available, recapitalisation should be funded via a loan from the EFSF in the case of
Eurozone countries.”

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