Monday, February 22, 2010

Will New Bond Issue Solve Greek Debt Worries?

Financial Times: Greece Set for Critical Test with Bond Issue
Financial Times: Greece Ponders High-Risk Bond Move

Petros Christodoulou, treasurer at the National Bank of Greece, was just appointed as new senior debt commissioner Friday, replacing Spyros Papanicolaou as the head of Greece’s Public Debt Management Agency. Papanicolaou was let go amidst negative speculation regarding his issuance of the latest five-year Greek bond issue. Newly appointed Christodoulou has a challenge on his hands because the Greek government has little time to issue €53 billion in bonds to cover upcoming debt maturities at higher costs than the original debts.

This task will be a challenge because Greek debt yields have skyrocketed in the wake of Greece’s current financial troubles (see Greece's Financial Troubles). Higher yields means that Greece will have to pay higher premiums to its bondholders on any new debt it issues during its struggle to get its finances under control.

Usually a sovereign nation only has to pay a small premium (5-10 basis points) when it issues bonds similar to its existing bonds with commensurate maturity dates. But because of Greece’s financial woes, investors are speculating that the premium will be more like 20 basis points, or double the usual cost. The Prime Minister of Greece would like to avoid this premium, requesting that investors allow it to issue new debt on the same terms as other European countries.

This high bond pricing could cause a crowding out effect for corporate bonds because similarly rated corporate bonds are trading at rates lower than the same rated sovereign bonds. Ratings agencies could increase corporate debt spreads to match sovereign spreads, increasing the cost of borrowing for companies. It could also cause problems for other European countries whose sovereign debt premiums could rise as investors reconsider euro-zone pricing and the potential of an EU bailout.

Recent debt offerings in Spain, Portugal, and Ireland—other European countries struggling with weak finances—might offer some hope to Christodoulou. On Wednesday Spain raised €5 billion of debt at just over 1% of the pricing for German bunds, the industry benchmark. Cynical investors wonder if Greece’s high deficit and sovereign debt pricing problems are just the beginning of a much bigger problem.

Discussion Questions
1. Who would bail out the EU if the monetary block fell into a monetary crisis?
2. Might an all-European debt premium readjustment cause a contagion effect and trigger a true sovereign crisis?

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