Markets await Greek Vote on Austerity Plan

As Greek unions continue their 48-hour general strike before the vote by lawmakers on the proposed five-year austerity plan on Wednesday, markets have been slightly optimistic today. Given that European stock indices are up today (with banking stocks particularly strong), Greek 10yr bond yields are at a three-week low and CDS spreads have tightened, it looks as if the market is quietly betting on Greece's Prime Minister George Papandreou to gain lawmakers' support in tomorrow's vote. The decision on whether or not to pass Papandreou's €28bn austerity measures is a crucial one that will likely have a significant impact on the financial markets, considering that a failure to pass the plan could result in the euro area's first sovereign default. After all, Greece will only receive the fifth €12bn installment of the €110bn bailout from the EU and the IMF if its parliament will vote in favor of Papandreou's plan. The tranche will ensure that Greece will be able to pay creditors through mid July. After that, the country will be dependent on a new EU/IMF bailout package believed to be worth €120bn that, too, is conditional on the passage of the austerity program and the laws needed for its implementation.

Meanwhile, European banks are discussing ways of contributing to this second rescue package for Greece. French institutions announced they would be willing to roll over 70% of their Greek debt maturing between 2011 and 2014. Apparently, 50% of the proceeds from those bonds would be reinvested in new 30-year bonds with the remaining 20% to be invested in zero-coupon AAA bonds with deferred interest. It is possible that the new bonds will be placed in a special purpose vehicle (SPV) backed by the European Financial Stability Facility (EFSF) so they won't show up in the banks' balance sheets anymore. According to Deutsche Bank's Josef Ackermann, German banks are looking into the French model as well as other possiblities, too. Although it was Germany's Angela Merkel who first proposed a private sector participation, again it is Nicolas Sarkozy who seems to be getting things done. Mrs Merkel continues to appear indecisive when it comes to actually closing deals instead of merely coming up with possible strategies. Anyway, France has a special interest in Greece not defaulting on its debt, because French banks have the biggest exposure to Greek debt with €65bn in liabilities. Next in line is Greece itself with around €59bn, followed by Germany (€40bn) and the UK (€19bn). The ECB remains the largest single creditor with €49bn worth of Greek bonds on its balance sheet.

The private sector's search for a good strategy for helping with the rescue of Greece is also made difficult by the fact that rating agencies could classify such an undertaking as a default event, depending on how it were to be executed. Fitch already said it was likely that the company would cut Greece to default if the EU were to go through with its plan to have private investors roll over their Greek debt. In any case, it is very important that the Greek parliament will back its Prime Minister on Wednesday. This will send positive signals to investors worldwide. I am not sure anymore whether Greece can be saved from defaulting, though. It is important for the EU to have a strategy in place for such a scenario. An orderly default of Greece might be unavoidable in the long run if the EU's other member states do not want to throw ever more good money after bad.