Paying the locusts – what the PSI means for Greek bond investors

Early this morning it appears that at last Greece and the European authorities are at the final stages of  launching a bond swap with the private sector – known as the private sector involvement (PSI) procedure – which will aim to reduce Greece’s debt-to-GDP ratio to 120.5 percent by 2020 (currently 160 percent). The deal will receive blanket press coverage, we are going to focus on the PSI element.

The PSI ensures that the private sector will suffer a real loss while the public sector (national European central banks and the ECB) will not suffer any losses. Central banks have this privileged position as they are prepared to provide further finance to Greece (akin to a rescue rights issue diluting existing shareholders). Of course, it is not in the politicians’ interests for the central banks to bear any losses as a result of lending to Greece and of course it is the politicians that set the legal and regulatory framework. Not only can politicians change the goal posts, they can change the ball you are playing with. Politicians, and the authorities, are exercising their imbedded power.

This deal will cause the private sector to suffer a disproportionate level of losses both in absolute and relative terms to the public sector. This punishes the private sector investor in Greek debt relative to the private speculator who was short Greek debt. We noted in an earlier blog that governments perceived owners of their debt to be good investors, whilst investors holding short positions in government debt are evil speculators.

The problem with the PSI procedure is that it does not reward these economic agents accordingly. This PSI precedent means that in the future, should a government debt crisis occur, private investors will be less willing to support troubled government debt, and speculators will be rewarded for being short. Obviously this will impact the sustainability of government finances at precisely the time they would be seeking to generate confidence in their ability to service their debt obligations.

What does this PSI look like in pounds, shillings, and euro cents? Those investors that are short Greek debt will make money, the legal power of the state means the authorities suffer no damage, while the private sector will suffer losses. The locusts will feed well, the authorities will not eat less, and the private investor will waste away.