Making sense of the Greek crisis

Architas senior fund manager Dawn Kendall examines the current financial situation in Greece and considers the possible impact for the wider European community.

Shakespeare’s Timon of Athens is surprisingly appropriate for the present financial crisis that Greece finds itself in. To paraphrase Flavius, “we have seen better days”.
Timon was a wealthy man whose pleasure was giving gifts to his friends. His ruin came through his inability to support his spending; he took loans from his friends to pay for the very gifts he gave them. Eventually he was forced to mortgage all his holdings and became bankrupt, abandoned by his friends.

Although originally written as a metaphor for the behaviour of James I and his court in the 17th century, it is equally relevant to the position many peripheral EU members find themselves in today. Encouraged by wealthier neighbours to equalise living standards across the EU, funded by easy credit and low interest rates, Greece and others have accumulated unsustainable levels of debt.

As with Timon, the Greek government should no longer rely on the ties of friendship and political expediency to support further debt burden. The ratings agencies Fitch, Moody’s and Standard & Poors have all declared Greece must face up to her debt liabilities to avoid further European contagion for European banks.

The International Monetary Fund (IMF) and the European Central Bank (ECB) were not particularly helpful until politicians gave a clear signal.

The European experiment

The present debt crisis in Europe has been exacerbated by the leadership vacuum at the centre of the Union. Going some way to assuage market fears was the news that after a seven hour Franco-German meeting, they had agreed a joint stance on a way forward in solving the Greek debt debacle.

George Osborne wrote last month that the only way forward for the euro was for greater economic union and he contributed to the debate regarding potential for the issue of a European-wide debt issue. These ideas would have been considered unthinkable two years ago but have now grown in credibility as the realisation dawns that the long-term survival of the “European experiment” itself is debated.

It is important to understand the context this present-day drama is being conducted within. Bond markets have experienced very high levels of price movement on little volume. Italy, UK and peripheral European sovereign bonds have suffered sharp movements, high yield corporate spreads have traded more than 75 basis points wider.

In particular, price action in Italy has been very volatile and unwarranted – yes, Italy does have high debt burden, more than Germany, but more relevant is Italy’s announcement of robust austerity measures. If successful, the structural deficit will be removed by 2014. A steep hill to climb and markets will regard any deviation from plan starkly. So, although 4% movements are not unusual in transparent, exchange-traded equity markets, for bonds it is highly irregular but something we may have to start becoming more accustomed to.

EU summit: the facts

Given the need for certainty from markets, it is somewhat surprising that the deal resulting from the EU summit in Brussels in July was yet another attempt to address the Greek problem. Let’s be clear about the salient facts of the deal:

• A new €109bn loan facility
• Loans to be extended for a second time from seven and a half years to 15 and 30 years with 10-year flexibility
• Interest rate on these loans is reduced to 3.5%.

Doing simple bond maths, this effectively means the maturity profile becomes 40 years and represents a 20% discount for present holders of debt, which is a lot.