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In the eye of the storm: the debt crisis in the European Union

Eric Toussaint

Publishing Date: September 12th 2011

First part: Greece

CADTM: Is it true that Greece has to commit to paying about 15% interest rates to be allowed to contract ten year loans?

Eric Toussaint: Yes, it is; markets are only ready to buy the ten-year bonds Greece wishes to issue on condition it commits to paying such extravagant rates.

CADTM: Will Greece contract ten-year loans on such conditions?

Eric Toussaint: No, Greece cannot afford to pay such high interest rates. It would cost the country far too much. Yet almost every day we can read in both mainstream and alternative media (the latter being essential to develop a critical opinion) that Greece must borrow at 15% or more.

In fact, since the crisis broke out in spring 2010, Greece has borrowed on the markets for 3 months, 6 months or 1 year, no more, at interest rates ranging between 4 and 5%. |1| Note that before speculative attacks against Greece started, it could borrow at very low rates since bankers and institutional investors (pension funds, insurance companies) were eager to lend.

For instance, on 13 October 2009, it issued three month Treasury bonds, also called T-Bills, with a very low yield of 0.35%. On the same day it issued six month bonds at a 0.59% rate. Seven days later, on 20 October 2009, it issued one year bonds at 0.94%. This was less than six months before the Greek crisis broke out. Rating agencies had given a very high rating to Greece and the banks that were granting one loan after another. Ten months later, it had to issue six month bonds at a 4.65% yield - in other words, 8 times more. This denotes a fundamental change in circumstances.

Another significant fact points to the banks’ responsibility: in 2008 banks demanded a higher yield from Greece than in 2009. For instance in June-July-August 2008, before the crash produced by the Lehman Brothers bankruptcy, rates were four times higher than in October 2009. They were at their lowest (below 1%) in the fourth term of 2009. This may seem irrational, since a private bank is certainly not supposed to lower its interest rates in a context of major international crisis, least of all with a country such as Greece, which is prompt to borrow; but it was perfectly logical from the point of view of bankers out to maximize profits while relying on public rescue in case of trouble. After the Lehman Brothers bankruptcy, the governments of the US and European countries poured huge amounts of cash to bail out banks, restore confidence and boost economic recovery. Banks used this money to lend to countries such as Greece, Portugal, Spain and Italy, convinced as they (rightly) were that if there were any problem, the ECB and the European Commission would help them out.

CADTM: You mean that private banks deliberately pushed Greece into the trap of an unsustainable debt by offering low interest rates, then demanded much higher rates that made it impossible for Greece to borrow beyond a one year term?

Eric Toussaint: Yes, exactly. I don’t mean that there was some sort of plot but it is obvious that banks literally threw capital into the arms of countries such as Greece (notably by lowering the interest rates they demanded) since they considered that the money they so generously received from public authorities had to be turned into loans to Eurozone countries. We have to bear in mind that only three years ago States appeared to be the more reliable actors while the capacity of private companies to repay their debts was questionable.

To go back to the concrete example mentioned above, on 20 October 2009 the Greek government sold its three-month T-Bills with a 0.35% yield in an attempt to raise EUR 1,500 million. Bankers and other institutional investors proposed about five times this amount, i.e. 7,040 million. Eventually the government decided to borrow 2,400 million. It is no exaggeration to claim that bankers literally threw money at Greece.

Let us also go back to the time sequences in the increase of loans granted by West European banks to Greece between 2005 and 2009. Bankers of Western European countries increased their loans to Greece (to both public and private sectors) in several stages. Between December 2005 and March 2007, the amount of loans increased by 50%, from just under USD 80 billion to 120 billion. Although the subprime crisis had broken out in the US, loans increased again, this time by 33%, between June 2007 and summer 2008 (from 120 to 160 billion), then they stayed at a very high level (about 120 billion). This means that Western European private banks used the money they received at very low rates from the ECB, the Bank of England, the US Federal Reserve and the US money market funds (see below) in order to increase their loans to countries such as Greece without taking risk into consideration. Private banks thus bear a heavy responsibility for the crushing debts of Greece. Greek private banks also loaned huge amounts to public authorities and to the private sector. They too have a significant responsibility in the present situation. Consequently the debts claimed from Greece by foreign and Greek banks as a result of their irresponsible policy should be considered illegitimate.

Part 2: The great Greek bond bazaar

CADTM: You say that since the crisis broke out in May 2010 Greece has stopped issuing 10-year bonds. Why then do markets demand a yield of 15% or more on Greece’s 10-year bonds?

Eric Toussaint: This has an influence on the sale price of older Greek debt bonds exchanged on the secondary market or on the OTC market. There is another much more important consequence, namely that it forces Greece to make a choice between two alternatives:

a) either depend even further on the Troika (IMF, ECB, EC) to get long-term loans (10-15-30 years) and submit to their conditions; b) or refuse the diktats of markets and of the Troika and suspend payment while starting an audit in order to repudiate the illegitimate part of its debt.

CADTM: Before we look at these alternatives, can you explain what the secondary market is?

Eric Toussaint: As it the case for used cars, there is a second-hand market for debts. Institutional investors and hedge funds buy or sell used bonds on the secondary market or on the OTC (over the counter) market. Institutional investors are by far the main actors.

The last time Greece issued ten-year bonds was on 11 March 2010, before speculative attacks started and the Troika intervened. In March 2010, to get 5 billion Euros, it committed itself to an interest rate of 6.25% every year until 2020. By that date it will have to repay the borrowed capital. Since then, as we have seen, it no longer borrows for ten years because rates blew up. When we read that the ten-year interest rate is 14.86% (on 8 August 2011 when the 10-year Greek rate, which had been as high as 18%, was again below 15% after the ECB’s intervention), this indicates the price at which ten-year bonds are exchanged on the secondary or OTC markets.

Institutional investors who bought those bonds in March 2010 are trying to sell them off on the debt secondary market because they have become high risk bonds, given the possibility that Greece may not be able to refund their value when they reach maturity.

CADTM: Can you explain how the second-hand price of the ten-year bonds issued by Greece is determined?

Eric Toussaint: The following table should help us understand what is meant by saying that the Greek rate for ten years amounts to 14.86%. Let us take an example: a bank bought Greek bonds in March 2010 for EUR 500 million, with each bond representing 1,000 euros. The bank will cash EUR 62.5 each year (i.e. 6.25% of EUR1,000) for each bond. In security market lingo, a bond will yield a EUR 62.5 coupon. In 2011 those bonds are regarded as risky since it is by no means certain that by 2020 Greece will be able to repay the borrowed capital. So the banks that have many Greek bonds, such as BNP Paribas (that still had EUR 5 billion in July 2011), Dexia (3.5 billion), Commerzbank (3 billion), Generali (3 billion), Société Générale (2.7 billion), Royal Bank of Scotland, Allianz or Greek banks, now sell their bonds on the secondary market because they have junk or toxic bonds in their balance sheets. In order to reassure their shareholders (and to prevent them from selling their shares), their clients (and to prevent them from withdrawing their savings) and European authorities, they must get rid of as many Greek bonds as they can, after having gobbled them up until March 2010. What price can they sell them for? This is where the 14.86% rate plays a part. Hedge funds and other vulture funds that are ready to buy Greek bonds issued in March 2010 want a yield of 14.86%. If they buy bonds that yield EUR 62.5, this amount must represent 14.86% of the purchasing price, so the bonds are sold for only EUR 420.50.

 

Nominal value of a 10-year bond issued by Greece on 11 March 2010

Interest rate on 11 March 2010

Value of the coupon paid each year to the owner of a EUR1,000 bond

Price of the bond on the secondary market on 8 August 2011

Actual yield on 8 August 2011 if the buyer bought a EUR 1,000 bond for EUR 420.50

Example

EUR 1,000

6,25%

EUR 62,5

EUR 420,50

14,86%

To sum up: buyers will not pay more than EUR 420.50 for a EUR 1,000 bond if they want to receive an actual interest rate of 14.86%. As you can imagine, bankers are not too willing to sell at such a loss.

CADTM: You say that institutional investors sell Greek bonds. Do you have any idea on what scale?

Eric Toussaint: As they tried to minimize the risks they took, French banks reduced their Greek exposure by 44% (from USD 27 billion to USD 15 billion) in 2010. German banks proceeded similarly: their direct exposure decreased by 60% between May 2010 and February 2011 (from EUR 16 to EUR 10 billion). In 2011 this withdrawal movement has become even more noticeable.

CADTM: What does the ECB do in this respect?

Eric Toussaint: The ECB is entirely devoted to serving the bankers’ interests.

CADTM: But how?

Eric Toussaint: Through buying Greek bonds itself on the secondary market. The ECB buys from the private banks that wish to get rid of securities backed on the Greek debt with a valuation haircut of about 20%. It pays approximately EUR 800 for a bond whose value was EUR 1,000€ when issued. Now, as appears from the table above, these bonds are valued at much less on the secondary market or on the OTC market. You can easily imagine why the banks appreciate being paid EUR 800 by the ECB rather the market price. This being said, it is another example of the huge gap between the actual practices of private bankers and European leaders on the one hand and their discourse on the need to allow market forces to determine prices on the other.

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