Greek Lessons for Putin

by Roy C. Smith

After the “cram-down” restructuring of Greek private sector debt in 2012 that forced a 75% haircut, in a transaction officially scored as a default, financial markets resounded with cries of “never again.”

But Greece’s oversubscribed €3 billion 5-year bond issued on April 10^th with a coupon of 4.75%, 50 basis points below its expected level, shows yet again that markets have short memories, and that “opportunities” changes.

True, the bond was rated a barely breathing Caa3 by Moody’s and the Greek economy continues to be a mess after six years of recession with 26% unemployment, a still sky-high debt burden, and continued political unrest, there is a bright side -- especially if you are a “trader” as opposed to a traditional “long-term investor.”

Traders who bought Greek 10-year bonds a year ago have enjoyed market gains of 33%. They will tell you that the expectation of a near-term default of private sector debt is very unlikely. After all the struggle within the Eurozone to determine whether and how to bail out Greece, the country is back in the euro fold and the continuing support of the EU and its agencies can be assumed. With their help, and after the 2012 restructuring, Greek debt service is reasonably assured for about 10 years, whereas the new bonds mature in five.

The traders will also tell you that €3 billion is a tiny fraction of the €320 billion of Greek debt outstanding before the issue, 85% of which is owned by the IMF, ECB and similar government bodies. The new bonds are issued under UK law, which means a default would be accompanied by lots of messy litigation with collateral grabbing of the sort Argentina has been experiencing.

Besides, the traders might add, we’re getting a much higher yield on these 5-year bonds than on Portuguese (2.5%) or Irish (1.4%) bonds issued within the last year. Fixed-income investors are desperate for yield in the current European low inflation environment.

Traders, of course, are not your traditional, stodgy, hold-until-maturity bond investors. They are a different breed altogether, comprising proprietary traders, hedge funds, high-yield bond funds, and ETFs. Most manage large amounts of money for pension funds, endowments and wealthy families. They think opportunistically with time horizons of six-months to a year and move into and out of things quickly. Such traders are the ones behind the apparent bubble in the low-grade sovereign and corporate bond markets that has been inflating for the last couple of years.

Traders are in equity markets too, as followers of social media stocks will confirm. Facebook recently announced it would pay $19 billion to acquire WhatsApp, an incredible amount for a company with few revenues and no earnings. Facebook, with a market capitalization of $170 billion, will pay for the deal with stock trading at over 100 times earnings, something it can continue to do as long as it retains market support.

Indeed, traders buy and sell a lot more often than long-term investors, so they tend to be the ones setting prices in the markets. Often they pursue the same market opportunity (e.g., tech stocks in the 1990s, mortgage-backed securities from 2003-2007) and turn them into bubbles. But they can also abandon markets suddenly as they did in 2000 to the tech stocks, and in 2008 for mortgage backed securities, turning these events into crashes.

After the euro was introduced in 1999, the differences between German government bond yields and those of all the other EuroZone countries (including Greece) were negligible, despite major differences in their financial and economic positions and outlooks. Traders assumed that the system would underwrite any troubled members, but in 2010, when the European banking crisis contaminated sovereign credits, they rushed for the exits. Greek 10-year yields reached 30% before the crisis was resolved and markets relaxed.

So the real Greek lesson is that, for countries plugged into the global financial system, markets forces can be extremely helpful when they are going in the right direction -- lowering interest rates, providing access to easy credit, encouraging foreign direct investment and higher stock prices -- but equally, when market forces are in opposition, they deny access to credit, sink stock markets and block inward direct investment.

Market forces make a huge difference to growth and stability in all economies, but especially in developing and emerging market countries. Thus, governments must align their economic policies to gain the support – not the opposition – of market forces.

Maybe Mr. Putin should sign up for a Greek lesson. Though Russia’s 10-year sovereign debt reached a peak yield of 16% during the financial crisis, it recovered to a low of 6.24% in 2011. The yield was 7.2% last October, before the Ukrainian crisis began, and is now 9% (a 25% increase).

By comparison, Greek government 10-year bonds are now yielding 5.9%.  Russia has also seen a 20% decline in stock prices, a 15% decline in the value of the Ruble, and a capital outflow estimated at $100 billion since the crisis began.

As powerful as Mr. Putin may see himself to be, he is nowhere near as powerful as financial markets. Unlike the times of his Soviet predecessors, Russia is now part of the global financial system and must endure its reaction to Russian policies and actions.

Russia has benefitted greatly from positive market forces since its independence in 1991, but as these forces reverse, things start to look much worse. The IMF is now estimating Russian GDP growth for 2014 at -1.6% (it was 4.5% in 2011 and 2012).

But if the Ukrainian situation gets worse, especially if major sanctions are involved, the combined impact on the Russian economy of negative market forces could more than equal those that buried Greece in economic misery for six years.