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The Proposed EU Sovereign Debt Agreement

With the news arriving earlier this morning EST, in a very significant, yet not completed, agreement EU leaders and Greek bondholders settled on a 50 percent writedown on Greek debt. Additionally, the agreement provides for 1) a recapitalization of European banks, 2) a potentially bigger role for the International Monetary Fund, 3) a commitment from Italy to further reduce debt levels, 4) the ECB continuing to maintain bond purchases in the secondary market (and proposed to increase such capacity to 1 trillion euros ($1.4 trillion), 5) 130 billion euros of official aid (up from 109 billion euros as proposed in July), and 6) the IMF agreed to disburse its 2.2 billion-euro share of the next installment of Greece’s original bailout, 7) the euro rescue fund (EFSF, an acronym we will frequently hear and read) will be used to insure bond sales and to create a special investment vehicle that would raise outside money from public and private financial institutions and investors (China is being solicited), 8) a bank-recapitalization accord with a June 30, 2012 funding date was established, by which lenders are to attain core capital reserve of 9 percent after writing down their sovereign-debt holdings; banks not able to attain this reserve level would be unable to pay dividends and award (compensation) bonuses, and 9) - regarding 8) - banks that fail to raise enough capital on the markets will first tap national governments, with the EFSF as a back stop. 


In a presentation that should provide more details, Greek Prime Minister Papandreou will speak to the nation later today and cite the agreements effect on Greece.

For investors' considerations, on the agreement news today the euro rose to a seven-week high against the dollar, rising above $1.40 for the first time since September. Dow and S&P equity futures are up 2% presently, the Stoxx Europe 600 Index surged 2.6 percent. EU economists and bankers this morning were expressing uncertainty regarding any additional meaningful euro valuation advances post this agreement. Despite these views, it is clear that a final agreement will have a very meaningful and positive effect on the stability of the eurozone, the euro, and the global financial system and creditor and borrower confidence. Certainty is good for investors and economies, however there are final agreement details to be resolved.

One of the major considerations that caused the eurozone leadership collaboration was the need to cut Greece’s debt to 120 percent of gross domestic product by 2020 from a forecast of about 170 percent next year.
As a result, it appears eurozone bankers - lenders - now understand that without an agreement there is the reality of Greece's complete insolvency, resulting in heavy bank losses which certainly is not desired. Further, without an agreement holders of Greece bonds would have potentially realized a far greater loss in capital.

This morning (EST) Greek, Spanish, Italian and French bonds rallied; spreads over benchmark German bonds narrowed. The yield on 1) German 10-year bonds increased eight basis points, 2) Greek bonds due in October 2022 fell 117 basis points to 24.15%, 3) Spanish 10-year yields dropped 16 basis points to 5.32%, and 4) Italy’s 10-year bonds advanced for a second day, with yields falling 13 basis points to 5.81%.

The long view now should focus on the broader agreement's impact on global and regional financial services equity valuation forecasts, and perhaps lending policies; among other considerations. Last night I was speaking with a friend about the evolving EU discussions, and I proposed the following thought - it is interesting to ponder a hypothetical proposal to have U.S. banks writedown 50% of residential mortgage debt that is not supported by residential home values, and not requiring the same banks to take a charge against capital nor require homeowners to recognize the mortgage debt reduction as taxable income; as a result, would consumer sentiment and purchases increase, and bank loan levels result in additional bank capacity to make continued prudent loans to a more confident business sector, who in turn expand their enterprises - all in combination to potentially accelerate U.S. economic growth and jobs creation? An Interesting thought.

More to come as the October 27 EU agreement details become known. Certain resource material for this summary was compiled from a number of sources, including Bloomberg, CNN, EU financial sources, audio interviews, and others.

 

Timothy Speiss is the Partner-in-Charge of EisnerAmper's Personal Wealth Advisors Group and Vice President of EisnerAmper Wealth Planning LLC. He chairs our Asia Practice and is a member of the firm’s community service group, EisnerAmper Cares.

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