AMERICAN FUTURE

The final statement from the eurozone summit is available here.

SECTION I. FROM THE FINACIAL TIMES

The FT’s initial reaction is a mixture of relief and skepticism. This is what the Lex column has to say:

The euro survives, until the next summit.The summiteers appear to realise that a solution to the sovereign debt crisis has been staring them in the face all along: the European financial stability facility. This body’s scope and financial firepower are to be greatly expanded. As a start, the cost of its lending to Greece, Ireland and Portugal will be cut to 3.5 per cent, and maturities doubled to 15 years. That concrete act should have immediate benefits for those three countries – and lasting effects on the eurozone’s fiscal cohesion.

All of this is positive. Yet the market reaction still looks a little extreme. The FTSE-Eurofirst 300 eurozone banks index has risen by 14 per cent in three days. Yields on Greek two-year bonds were 6.3 percentage points tighter at the close on Thursday than at the open. The Italian 10-year yield has fallen to below 5.4 per cent, from 6 per cent (still uncomfortably above the 5 per cent level). But then, the communiqué is an invitation to buy Italian and Spanish bonds. Talk about moral hazard.

The sticking point, as ever, is private sector involvement, which remains distractingly complex. The “financial sector” (all of it?) has shown its “willingness to support Greece on a voluntary basis” through “a menu of options”, to the tune of a net €37bn. “Credit enhancement will be provided.” That sounds almost like a bribe. But, as governments are now committed to keeping the euro alive, it would be perilous for investors to bet against them.

In another article, the FT avers that the ratings agencies will consider Greece to be in default:

Strategists expect all three main rating agencies to determine that Greece has defaulted, because bondholders will suffer losses whatever plan policymakers decide to adopt involving private creditors. The options are debt exchanges, rollovers or buy-backs.

Although all three rating agencies were not commenting on Thursday, strategists say Standard & Poor’s is likely to put Greece on selective default [see Section III of this post to find out what a "selective default" means], while Fitch will follow a similar route and put the country on restricted default, which is the same thing.

Strategists assume Moody’s will announce that Athens is in default, even though the agency does not have a specific default rating.

The terms “selective” and “restrictive” default mean Greece as an issuer will default, but only some of its bonds will be downgraded. Bonds that are not affected by whatever private creditor plan is used will not be defaulted.

[...] Many strategists say a default may not have a big effect on the market as Greece would only default on a temporary basis. Both Standard & Poor’s and Fitch are likely to upgrade the country’s rating back to triple C, a low junk-grade status, once the debt exchange, rollover or buy-back has been initiated to reflect a forward-looking view of Athens, with its reduced debt burden.

In a further article, the FT says that “[o]n average investors would take a 21 per cent hit in the net present value of their current bond holdings.

SECTION II. FROM THE ECONOMIST

In its initial take, the Economist asks whether its “Russian, or Belgian Roulette?”

Much of the attention in recent months has focused on the “involvement” of private creditors—nobody wants to talk of debt “restructuring”—and whether it would be construed as a selective default by credit-rating agencies.

But the most certain and immediate restructuring is not of the loans by the private sector, but of those by official lenders from the euro area. The interest on the euro-zone’s portion of the future Greek bailout is being reduced from about 5.5% to about 3.5%. Greece, then, is being allowed to borrow money as cheaply as an AAA-rate country. [My emphasis] Moreover, the maturity on current and future loans would be extended from 7.5 years to a minimum of 15, perhaps even 30 years. Were such terms applied to private lenders, credit-rating agencies would have no doubt about calling it, at the very least, a selective default.

All this is meant to “decisively improve the debt sustainability and refinancing profile of Greece”. Number-crunchers say the effect will be noticeable, but not dramatic. At the end of its rescue programme in 2014, Greek debt will still be worryingly high, they say. What the IMF is most excited about is the commitment “to continue to provide support to countries under programmes until they have regained market access, provided they successfully implement those programmes”. In other words, the EU appears to have given Greece, Ireland and Portugal – and any other country that may need to be bailed out – an indefinite commitment of financial support. [my emphasis]

This promise may well be tested when the current Greek programme ends in 2014. Will euro area countries really be willing to provide fresh funds if Greece is still unable to borrow in the bond markets?

No one knows or can know how long it will take Greece to regain access to the private market. If the Economist’s interpretation is correct, the EU is on record as being willing to provide bailouts of possibly infinite duration to the eurozone’s financially-challenged members. Would voters in the financially-strong members — especially in Germany — stand for it? Governments could fall over such an issue.

SECTION III. FROM THE EUROPEAN EDITION OF THE WALL STREET JOURNAL (no links)

How a “selective default” works:

Q: Thursday’s deal by euro-zone leaders means Greece is likely to be declared in “selective default” by credit-rating firms. What does this mean?

A: It’s a technical assessment that means investors in some Greek bonds will be worse off as a result of the deal. It implies holders of other bonds are still being repaid in full and on time.

Q:How significant is it?

A: Most selective default ratings last only a short time. Euro-zone leaders are hoping the deal, which reduces Greece’s debt burden and provides more official loans, will convince credit raters that chances of full repayment on remaining debt are improved.

Q: But euro-zone leaders spent months fighting selective default, worrying investors might fear other countries could go down the same default path. Isn’t that still a concern?

A: That depends on financial markets. Euro-zone leaders have done what they can to paint Greece as a special case—indeed, its debt is by far the highest as a proportion of annual economic output of any euro-zone country—and to emphasize that other governments will pay their debts in full and on time. They have also provided the euro-zone bailout funds with new tools aimed at preventing others from sliding into debt difficulties.

Q: The European Central Bank has been arguing it won’t accept defaulted bonds as collateral for its loans. That would have threatened Greek banks, which it has propped up with tens of billions of euros of loans.

A: ECB President Jean-Claude Trichet got euro-zone governments to agree they would indemnify the ECB for losses of up to €35 billion ($50 billion) if collateral proved inadequate. It looks as if Greek bonds will, as a result, still be acceptable at the ECB.

On the economic slowdown in the eurozone:

The euro-zone economy is now flat-lining at best, judging by the advance euro-zone Markit Purchasing Managers Index for July. It came in way below the consensus forecast at 50.8, the lowest level since August 2009 and close to the 50 mark that divides expansion from contraction. Both manufacturing and services activity slowed. Germany and France are expanding at the slowest pace in two years and the rest of the euro zone is contracting already, Markit says.

Earlier expectations of a second-half pickup are now doubtful. The spread of the sovereign crisis to Spain and Italy means it now affects countries making up 35% of euro-zone gross domestic product, versus the 5%-6% accounted for by Greece, Ireland and Portugal. Higher bank funding costs in these countries will force the pace of deleveraging. Ratings agencies are already concerned about growth in Spain and Italy.