TFTB: Clarifying A Few Facts On The "Greek Bailout"

This morning, as I was sitting on my balcony overlooking the ocean and sipping a very strong cup of coffee, I thought about the ongoings in Greece. As I began scanning headlines, I realized that there were several misconceptions about the current situation that were important to clarify. 

Contrary to popular belief and numerous press reports, a bailout for Greece was NOT approved or created. What did happen during this past weekend's massive negotiation session was nothing more than an agreement to work on a plan to obtain the approval for a bailout. In other words, Tsipras must ask the Greek parliament to implement an austerity program and agree to terms that are much harsher than those just rejected by the recent referendum. Such a request will not be easily accepted, and will likely lead to a revolt within Tsipras' party.

As one Eurozone Bank Official commented:

"Greece was asked to surrender unconditionally." 

But assuming that Tsipras can obtain approval, the Eurozone leaders will begin to negotiate the 3rd Greek bailout. According to the Atlantic:

"The deal states that Greece will get its bailout—an €86 billion loan—from the European Stability Mechanism (ESM), but, prior to approval by the European Commission, Greece must implement a series of reforms by Wednesday including measures to increase tax revenue, streamline its pension program, and "monetize" €50 billion of public Greek assets in a private fund to make ESM repayments and recapitalize banks. Under the new agreement, Greece will also have to make a request for continued support from the IMF to be considered for the ESM loan."

Let me remind you that the Greek economy is already in shambles. However, what the Eurozone is requiring of Tsipras is to renege on every promise that his party made to get elected. Furthermore, Greece was only given 72 hours to meet these requirements including pledging 25% GDP into a fund administered by the European Union. This precondition, which Greece must sign into law for a deal, would put Eurozone authorities at the ECB and in Brussels, rather than Athens, in charge of identifying and closing or breaking up sick banks and selling off Greek assets. 

If Tsipras completes this "Herculean" task, it will spell the end of his political career and will all but guarantee that Greece plunges into a far worse economic state. 

What does Tsipras get in exchange these actions; nothing more than a promise by the 18 other Eurozone leaders to start talks on a new bailout program. 

This is a horrible deal for Greece. Furthermore, it solves nothing long-term. Once again a deal was pushed through to keep banks/hedge funds solvent in the short-term. Providing a bailout to Greece so that they can pay the principal and interest on their debt does not begin to solve Greece's fiscal dilemma. It is equivalent to "rearranging deck chairs on the Titanic" and will not keep Greece from eventually sinking. 

Regardless, here is the timeline of the remaining obstacles

• July 14: Samurai bonds came due
• July 15: Greek Parliament must agree on terms per the agreement. 
• July 15-onward: Negotiations continue
• July 17: German government must get a parliamentary mandate to formally open negotiations with Greece on financial aid.
• July 20: Payment to the ECB – Greece is due to pay €3.5bn (£2.5bn) back to the ECB.

Importantly, while many headlines have opined that Greece got a bailout, the reality is that Greece is far from that point. Furthermore, as noted above, the German parliament first has to vote to authorize NEGOTIATIONS with Greece. Then if an agreement is reached, the German parliament must 'approve a final deal.' 

While Germany's approval is by far the most important, in order for talks to beginparliamentary approval is also required from the Finish, Dutch, Slovaks, Estonians and Austrians. In other words, there are a lot of moving parts to just begin talking, much less actually providing funding. 

It is worth reminding you at this juncture that even if Tsipras can secure the law changes required by the ECB, there is no guarantee that Greece will receive a fresh tranche of funds. The first raft of measures merely open the door for another set of grueling talks to secure a package from the eurozone bail-out fund (ESM), with yet more sweeping demands.

The IMF Wrench

One other point of concern arose on Tuesday that had not yet been factored in by the markets. The International Monetary Fund (IMF), who will supply a significant chunk of the funds required for a Greek bailout, may not be "on board" with this current plan.

According to the Financial Times:

"The International Monetary Fund has sent its strongest signal that it may walk away from Greece's new bailout programme, arguing in a confidential analysis that the country's debt is skyrocketing, and budget surplus targets set by Athens cannot be achieved.

'Greece's debt can now only be made sustainable through debt relief measures that go far beyond what Europe has been willing to consider so far,' the memo reads. Under its rules, the IMF is not allowed to participate in a bailout if a country's debt is deemed unsustainable and there is no prospect of it returning to private bond markets for financing. The IMF has bent its rules to participate in previous Greek bailouts, but the memo suggests it can no longer do so."

IMF support is critical to any agreement made with Greece. However, there has been NO willingness at this point for any"haircuts" on the debt that Greece owes. Unfortunately, someone, somewhere is eventually going to lose money, and the longer the game is played out, the worse it will be "when the music stops." 

As Ambrose Evans-Pritchard summed up:

"The findings are explosive. The document amounts to a warning that the IMF will not take part in any EMU-led rescue package for Greece unless Germany and the EMU creditor powers finally agree to sweeping debt relief.

This vastly complicates the rescue deal agreed by eurozone leaders in marathon talks over the weekend since Germany insists that the bail-out cannot go ahead unless the IMF is involved."

The problem for Germany, of course, is that if they accept debt write-downs to obtain IMF support in bailing out Greece; it would only be function of time before Italy, Spain and Portugal ask for the same. 

Today, we will see if Tsipras can indeed get his government to concede to a deal that is far worse for the country than any proposed previously. As Francesco Papadia ‏recently tweeted:

"The Greek case confirms the old maxim: sovereignty ends when solvency ends. If you prize the former; care for the latter. Greece forgot this."

Importantly, despite the majority of mainstream headlines that quickly suggested that the Greek crisis was resolved, the reality is far different. There are still numerous negotiations to be had and agreements to be made which leave open a significant possibility of further "shocks" to the financial markets. 

As John Hussman aptly noted this past weekend:

"However the Greek situation is resolved, prevailing and observable market conditions suggest that steep downside risks to the equity market remain quite general. As I noted last week, 'With valuations still extreme and deterioration in market action continuing to indicate a shift toward risk-aversion among investors, we are less concerned about specific factors such as Greece than about much more general pressures that threaten to force an upward spike in compressed risk-premiums.'"

John is absolutely correct. As I noted yesterday:

"For now, the 'bulls' remain in charge of the markets. This suggests that portfolios remain tilted toward equities currently.

However, the deterioration in momentum has triggered a 'confirmed sell' signal which suggests that while investors should remain invested, they should be much more cautious about the 'risk' undertaken in their portfolio. It is only as prices plunge that the realization of the mismatch of 'risk tolerance' sets in which eventually leads to 'panic selling' at the most inopportune time."

The events that are currently unfolding in Greece, and will likely continue to unfold for quite some time, are a distraction from the underlying deterioration in a market that is simultaneously over valued. As John pointed out:

"Valuations control long-term returns. Investor risk-preferences control outcomes over shorter horizons. The best measure of risk-preferences is the uniformity or divergence of market action across a wide range of market internals, credit spreads, and other risk-sensitive measures."

Currently, those measures are at levels that have historically led to poor outcomes. The problem, as always, is timing. When an expected outcome doesn't immediately occur it is dismissed as wrong, however, it is the dismissals that inevitably turn out to be the most damaging.