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Columnists
THE RACE IS ON FOR GREECE BEFORE THE ECB EXITS
By Gillian Tett
Financial Times (London)
February 5, 2010
http://www.ft.com/cms/s/0/49d36c86-11b7-11df-bceb-00144feab49a.html
A few years ago, Warren Buffett famously observed that it is only when the tide goes out, that you can see who is swimming naked.
It is a potent adage now. In recent months there has been much speculation about what might happen when central banks start to implement “exit strategies.”
Now we have a few clues. The Bank of England has just announced that it is freezing its quantitative easing [i.e. what non-economists call 'turning on the printing press'] program, spurring debate about the outlook for gilts [i.e. bonds issued by the governments of the United Kingdom]. However, to my mind, one of the most revealing sagas in relation to the exit strategy debate lies with the drama that has recently developed around the Greek debt world.
To most casual observers, it might seem as if the main reason why Greek bonds have recently tumbled in price is that investors have suddenly, and belatedly, woken up to the dire state of Greece’s fiscal problems.
But that tells only part of the tale: another factor that has also been hurting the Greek bond price is a subtle, albeit geeky, discussion that is quietly underway at the European Central Bank in relation to its collateral [i.e. borrower's pledge of specific property to a lender] policy.
Back in the autumn of 2008, after the collapse of Lehman Brothers, the ECB loosened the rules which govern how banks can get central bank funds. In particular, it let banks use government bonds rated BBB or above in ECB money market operations, instead of merely accepting bonds rated A-, or more.
This was initially presented as a “temporary” policy, slated to last until late 2009. But last year the ECB extended the policy until the end of 2010. Thus, during 2009, banks which were holding Greek bonds have been merrily exchanging these for other assets via the ECB. This, in turn, has helped to support Greek bond prices (and, by extension, Greek banks that hold a large chunk of outstanding Greek bonds).
Until recently, many observers thought -- or hoped -- that this policy would be extended again, perhaps until 2011 or beyond. For although Greek debt currently has a credit rating that meets the old ECB rules, there is a good chance the debt will be downgraded this year. This creates the risk that Greek bonds will be excluded from any newly tightened ECB regime.
Earlier this year, senior ECB officials indicated that they intended to “normalize” the policy, as planned, at the end of 2010, as part of their exit strategy. That has removed one key source of support for Greek debt (and spooked investors, such as German insurance companies, which also hold large chunks of bonds.)
Now I would not suggest for a moment that this collateral debate is the only reason for the Greek bond shock: there are clear macro-economic reasons for alarm, too. Moreover, the market gyrations have almost certanly been magnified by the sheer volume of speculative, hedge fund money now swirling around.
And in the coming weeks, it will be fascinating to watch what happens to those hedge funds. For there is a fascinating transatlantic divide at work in the investment world. In the eyes of many Wall Street players it now seems entirely logical, if not inevitable, that Greece will eventually default on its bonds or exit the euro, given the underlying fiscal maths.
To many European bankers and politicians, however, the focus on raw numbers misses the point. To them, this story is not just about economics, but politics, and the determination of a generation of leaders traumatized by the Second World War to maintain European unity, almost at any cost. And as the price of Greek debt has tumbled, and yields have risen, doughty figures at the heart of Europe are increasingly likening this to an “attack” on the euro, on a par with, say, the attack on sterling launched by George Soros two decades ago. The potential for some form of political backlash is running high.
Nevertheless, as emotions run high, the key point is that in a world where hedge funds tend to make their money by spotting and exploiting systemic fault lines, the Greek debt saga has exposed not one, but two such fault lines: namely the tangible level of government debt, and the exit strategy debate. Or to put it another way, while Greece’s problems might have been partly masked for much of the last year, the day of reckoning is approaching fast.
Perhaps Greece will manage to get its fiscal affairs in order fast enough to cope with a world where the central bank “tide,” as Buffett might say, goes out. Maybe countries like Spain and the U.K. will do so too. But some powerful investors are clearly now betting against that. Stand by for more drama, and not just in Greece.
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