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“Stand Together, Fall Together”

Written by: James Campbell and Sam Pearse

And so Greece paid the bond repayments due on Tuesday.  Some claim that making such a payment was a no-brainer on the basis that the otherwise ensuing litigation and cross-defaults on other bonds was unthinkable.  Other sources claim that the noise coming from Greece over last weekend was that the payment would be made and that it was never in doubt.  Yet initial Reuters reports on Tuesday morning of the bond repayment remained unconfirmed for a number of hours, with the payment due to be made in the afternoon.

There remains a large amount of unstructured, foreign law governed bonds and the holders of those instruments will take the view that there is now a commercial precedent for not agreeing to restructure the debt. Those who agreed to a 70 percent haircut on their bonds will be understandably furious and considering their options.  Either way, the decision to repay the bonds in full will have serious repercussions for any future debt restructuring and the sovereign bond market as a whole.  The system only works if bondholders can trust sovereigns.

The repayment of the capital has done nothing to dispel the unease about an imminent Greek exit from the Eurozone.  The arguments remain the same as before and can be captured under the heading of the cost of exit versus the cost of remaining propped up.  However, it is the not the debt writedowns, the cost of introducing a new currency or the unpicking of contracts that is the major concern.  We are seeing continued capital flight from the Eurozone as confidence continues to wane.  It is clear that contagion is spreading.

Is Greece the sea anchor that is dragging down the rest of the Eurozone?  The dumping of Italian and Spanish bonds and the selling of banking stocks in the Eurozone countries certainly evidences the contagion.  Indeed, it is Spain that appears to be the next country with a serious problem.  There are serious questions about the financial strength of the Spanish banks which have not yet be answered. The next bond sale is on Thursday May 17 and the expectation is that the cost of borrowing will markedly rise, especially as it was the Spanish banks that were the principal buyers of Spanish bonds last time around. 

If Greece’s troubles remain inadequately “firewalled” from the rest of the Eurozone then other vulnerable countries will continue to be dragged down.  If Greece alone defaulted that may be manageable, especially as external exposure to Greece’s well flagged troubles have been cut back over the past two years.  But if Greece goes and takes some or all of Spain, Portugal, Italy and Ireland with it then there is exponential damage that even the green shoots of recovery in the US may not withstand.  The longer Greece remains part of the Eurozone, the greater the likelihood that there will be widespread collapse.  For that reason, at the very least in the short term, funds should be reviewing their Spanish strategy and the terms of any Spanish paper they hold.