Is the Big Greek Deal Really Big?

•           JULY 22, 2011, 7:24 AM ET

By Stephen Fidler

Winston Churchill said Americans will always do the right thing, but only after exhausting all the alternatives. So, perhaps, the leaders of the euro zone, who gathered for yet another emergency summit in Brussels on Thursday, finally did the right thing—or at least recognized the gravity of their predicament.

Their problem is that the time they have taken in the process of exhausting all the alternatives has extracted a heavy cost.

Financial contagion acts like a ratchet, and it is very difficult to reverse damage done in an earlier phase of panic. But with Italy and Spain being drawn into the whirlpool, the leaders finally agreed a host of measures they had previously dismissed as impossible or unnecessary: cutting interest rates substantially on the bailout loans to Greece, Ireland and Portugal; allowing the bailout funds to buy back bonds, to make precautionary loans to governments and to provide financing to help authorities shore up bank capital.

As the measures leaked out, there was a relief rally for euro assets—and the euro itself. But it is in the nature of things that when the announcements are examined in more detail, the risks become more evident. My colleague Charles Forelle has already pitched in and I commend his post. But here are a few more non-exhaustive observations.

Greece’s debt isn’t reduced by much

Charles Dallara, managing director of the Institute of International Finance, told me last night that the private-sector contributions were “quite generous.” But it’s clear that at one stage the IIF was looking to cut more from the face value of the debt, perhaps through a bigger buyback.

It appears that €20 billion of the €109 billion in new official loans for Greece will be set aside for bond buybacks. That will buy back, according to official calculations, €32.6 billion of Greek bonds at just over 61 cents on the euro. Hence, the private sector contribution of €12.6 billion.

There are hopes for possible contributions by others—for which read sovereign wealth funds—for buybacks. But a reference to the potential for other buyers, contained in earlier drafts of the IIF financing offer, didn’t make it to the final version.

On top of that, there is an option to swap existing bonds for bonds, carrying credit enhancements, at a 20% discount to face value, which the IIF says will cut a further €13.5 billion from the face value of Greece’s debt.

So, given a net reduction of €26.1 billion in face value of a debt of €350 billion, it’s clear that most of the work to bring debt down to “sustainable” levels will be have to be achieved with the reductions in interest rates of official loans and private bonds. Plugging low interest rates into spreadsheets for Greece can eventually bring its debt to GDP ratio down considerably—but the devil is of course in the detail.

The private-sector participation target looks high

Another question relates to how much participation by financial institutions there will be in this “voluntary” deal. The IIF says it is targeting 90%: That looks high. To the extent that it falls short of this, even the modest level of debt reduction will be harder to achieve. (By the way, Mr. Dallara says the deal’s unlikely to be in place by August 20, when a €6.8 billion benchmark bond repayment falls due.)

European Central Bank president Jean-Claude Trichet said last night the bank was happy to sit on the Greek bonds it owns—estimated at about EUR48 billion. But the ECB won’t be participating in any bond exchange–or even, it appears, selling its bonds back to the Greeks at cost, as has been mooted. No debt reduction there.

The bailout fund has new tasks but no new money

The European Financial Stability Fund will be able to do significantly more—including help countries that are not in an official program, after there’s a suitable signal from the European Central Bank. But there’s no more money in the kitty to do it. That leaves the likelihood that this piece of unfinished business may have to be revisited. Officials argued yesterday, probably correctly, that there’s enough money in the pot to deal with likely contingencies for the next few months.

Which leads us on to the next issue:

Execution risk

Some of these changes, including the more flexible EFSF, are subject to parliamentary approval. One person close to the talks told my colleague Patricia Kowsmann that some leaders at the meeting said “parliaments will pose a problem,” adding “Slovakia has already warned that it likely won’t be able to get approval a more flexible EFSF.”