Greece in the eye of the storm

IS IT true that Greece has to commit to paying about 15 percent interest rates to find buyers for 10-year bonds?

YES, IT is. The markets are only ready to buy the 10-year bonds Greece wishes to issue on condition it commits to paying such extravagant rates.

WILL GREECE pay interest like this?

NO, GREECE can't 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 percent or more.

In fact, since the crisis broke out in spring 2010, Greece has borrowed on the markets for three months, six months or one year, but no more than that, at interest rates ranging between 4 and 5 percent. Note that before the speculative attacks against Greece started, the country could borrow at very low rates, since bankers and institutional investors (pension funds, insurance companies, etc.) were eager to lend.

For instance, on October 13, 2009, Greece issued three-month Treasury bonds, also called T-Bills, with a very low yield of 0.35 percent. On the same day, it issued six-month bonds at a 0.59 percent rate. Seven days later, it issued one-year bonds at 0.94 percent.

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, Greece had to issue six-month bonds at a 4.65 percent yield--in other words, an interest rate of eight times higher. 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 the period from June 2008 to August 2008, before the crash caused by the Lehman Brothers bankruptcy, rates were four times higher than in October 2009. They were at their lowest (below 1 percent) in the fourth quarter of 2009.

This may seem irrational, since a private bank is certainly not supposed to lower its interest rates in the context of major international crisis--least of all with a country such as Greece, which is quick to borrow--but it was perfectly logical from the point of view of bankers out to maximize profits while relying on public rescues in case of trouble.

After the Lehman Brothers bankruptcy, the governments of the U.S. and European countries devoted huge amounts of cash to bailing out the banks, restoring confidence and boosting economic recovery. Banks used this money to lend to countries such as Greece, Portugal, Spain and Italy, convinced as they were--rightly--that if there were any problems, the European Central Bank (ECB) and the European Commission would help them out.

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

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 could 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 financial actors, while the capacity of private companies to repay their debts was questionable.

To go back to the concrete example mentioned above, in October 2009, the Greek government sold its three-month T-Bills with a 0.35 percent yield in an attempt to raise 1.5 billion euros. Bankers and other institutional investors proposed about five times this amount--about 7 billion euros. Eventually, the government decided to borrow 2.4 billion euros. It's 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 in Western European countries increased their loans to Greece--to both the public and private sectors--in several stages.

Between December 2005 and March 2007, the amount of loans increased by 50 percent, from just under $80 billion to $120 billion. Although the sub-prime crisis had already broken out in the U.S., loans increased again between June 2007 and summer 2008--this time by 33 percent, from $120 billion to $160 billion. They then 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 U.S. Federal Reserve and the U.S. money market funds in order to increase their loans to countries such as Greece, without taking risk into consideration--and the same thing can be observed during the same timeframe with Portugal, Spain and Central and Eastern European countries.

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.

YOU SAY that since the crisis broke out in May 2010, Greece has stopped issuing 10-year bonds. So why do markets demand a yield of 15 percent or more on Greece's 10-year bonds?

THIS HAS an influence on the sale price of older Greek debt bonds exchanged on the secondary market or on the OTC (over-the-counter) market.

There is another much more important consequence--namely, that it forces Greece to make a choice between two alternatives: 1) either depend even more on the troika (International Monetary Fund, ECB and EC) to get long-term loans of 10, 15 and 30 years, and submit to their conditions; or 2) 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.

BEFORE WE look at these alternatives, can you explain what the secondary market is?

AS IS 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 OTC market. Institutional investors are by far the main actors.

The last time Greece issued 10-year bonds was on March 11, 2010, before the 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 percent 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 10 years because the interest rates blew up. When we read that the 10-year interest rate is 14.86 percent (on August 8, 2011, when the 10-year Greek rate, which had been as high as 18 percent, was again below 15 percent after the ECB's intervention), this indicates the price at which 10-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.

CAN YOU explain how the second-hand price of the 10-year bonds issued by Greece is determined?

LET US take an example: A bank buys Greek bonds in March 2010 for 500 million euros, with each bond representing 1,000 euros. The bank will cash 62.5 euros each year for each bond--that is, 6.25 percent of 1,000 euros. In security market lingo, a bond will yield a 62.5 euro 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 (which still had 5 billion euros in Greek debt in July 2011), Dexia (3.5 billion euros), Commerzbank (3 billion euros), Generali (3 billion euros), Société Générale (2.7 billion euros), 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 percent 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 percent. If they buy bonds that yield 62.5 euros, the purchasing price must be such that 14.86 percent of that price is 62.5 euros. So the bonds are sold for 420.50 euros--14.86 percent of 420.50 is 62.5.

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

YOU SAY that institutional investors sell Greek bonds. Do you have any idea on what scale?

IN TRYING to minimize the risks they took, French banks reduced their Greek exposure by 44 percent, from $27 billion to $15 billion in 2010. German banks proceeded similarly: their direct exposure decreased by 60 percent between May 2010 and February 2011, from 16 billion to 10 billion euros. In 2011, this withdrawal movement has become even more noticeable.

WHAT IS the role of the ECB in this respect?

THE ECB is entirely devoted to serving the bankers' interests.

BUT HOW?

THROUGH BUYING Greek bonds itself on the secondary market. The ECB buys from the private banks that wish to get rid of securities based on the Greek debt with a valuation haircut of about 20 percent. It pays approximately 800 euros for a bond whose value was 1,000 euros when issued. Now, as explained in the example above, these bonds are valued at much less on the secondary market or the OTC market. You can easily imagine why the banks appreciate being paid 800 euros by the ECB rather than the market price.

That said, this is another example of the huge gap between the actual practices of private bankers and European leaders on the one hand, and their discourse about the need to allow market forces to determine prices on the other.

Translated by Christine Pagnoulle and Vicki Briault in collaboration with Judith Harris