Voluntary bond buybacks to the rescue?
July 2, 2011 1 Comment
On Friday, the board of the Institute of International Finance (IIF) suggested its membership of over 400 of the world’s largest banks will consider Greek government bond buybacks alongside the French bank proposal for a voluntary Greek debt rollover. Will this help return Greece to solvency?
I explained why the French bank proposal was likely to fall short of targets in a post last week. If we assume markets are efficient, a voluntary bond buyback programme is also unlikely to return Greece to solvency.
A voluntary debt buyback programme would involve the Greek government offering to repurchase its debt from the banks holding it at the current, severely depressed market prices. The Greek government could use the funding it gets from the European Financial Stability Facility (EFSF) for these transactions. Participating banks would accept a writedown on the debt they were holding, but in exchange would reduce their exposure to Greece in the event of a debt restructuring.
If markets are efficient, a voluntary bond buyback would not significantly reduce the overall debt stock, even if a number of banks were to want to participate. Let’s imagine the EFSF lends enough to Greece that it can buy its way back to solvency. The markets will bake this into bond prices. Prices will rise and yields will fall, at which point the funding from the EFSF will no longer stretch far enough for Greece to repurchase the debt necessary to restore fiscal solvency. Rather than reduce overall debt levels, a bond buyback scheme would only serve to depress bond yields and, in turn, do little to improve Greece’s fiscal situation. Once it became clear that the EFSF funding would not reach far enough to return Greece to solvency, prices would fall and yields would return to their current elevated levels.