Introducing Brady Bonds, akin to Latin America’s in the 1980s, to Europe would represent a humiliating admission Europe's peripheral states are in essence emerging economies, but would be preferable to the current death by one thousand spending cuts, according to Renaissance Asset Managers.
Introducing Brady Bonds, akin to Latin America’s in the 1980s, to Europe would represent a humiliating admission Europe’s peripheral states are in essence emerging economies, but would be preferable to the current death by one thousand spending cuts, according to Renaissance Asset Managers.
It would allow beleaguered governments to restructure their debts and investors to make a market on their success, or lack thereof, said Simon Fentham-Fletcher, RAM’s portfolio manager for global asset allocation.
“It is time that peripheral Europe concedes it is now an emerging market and takes its medicine like the International Monetary Fund and World Bank made Brazil, Argentina, Bulgaria and many others take theirs,” he said.
Issuing Brady Bonds would allow Greek, Irish, and Portuguese debt to be converted into long-dated low-coupon bonds collateralized with European Financial Stability fund [EFSF] paper, he said.
Brady bonds were dollar-denominated paper created in 1989 for indebted Latin American countries and named after former-US Treasury secretary Nicholas Brady.
They allowed the conversion of bank loans to defaulting countries into various new bonds. In exchange for commercial bank loans, the new bonds the countries issued allowed commercial lenders to exchange claims into tradable instruments, so to move debt off their balance sheets, reducing the concentration risk to lenders.
Fentham-Fletcher said introducing them for Europe’s troubled periphery would “buy all these countries the time they need to make realistic structural adjustments instead of forcing more cuts on populations that are already rioting following the austerity already put in place.
“A European Brady Bond would in effect be a controlled default at the end of which investors would be left with more than just losses. They would hold tradable assets backed by a guarantee that some investors could make money off. They would also improve the ratings on each country’s residual debt and so make debt servicing manageable and affordable.”
But Fentham-Fletcher conceded introducing the bonds requires “a sea change in the eurozone’s mentality as it means equating EU member states with emerging markets.
“It was hard enough to accept the IMF’s help in dealing with Greece’s problems last May, without going the whole hog and introducing debt instruments specifically designed to help the basket cases of Latin America three decades ago. But if the Germans balk at another bailout, then there is little alternative to a messy default and pan-regional crisis that will cost a lot more to fix than some hurt pride.”
Few managers doubt Greece will default, possibly followed by fellow peripheral eurozone members. The question for many is only how orderly such a default can be organised.
“Just how much pain depends on what sort of rescue plan is put together. It could be very nasty, with the break-up of the eurozone and the peripheral counties condemned to five years or more of depression and social trauma. If it is done well – a managed collapse – then a line can be drawn under the decade of exuberance, fuelled by overly accessible credit, and a start made on fixing the eurozone’s fundamental flaws,” Fentham-Fletcher said.
“The story was the same in the peso crisis, the Asian crisis and the Russian crisis.”
He added: “How Italy, a middle-sized European state, could rack up €1.4trn of total external and internal debt is astounding. How Greece can provide a full pension with only 17 years of full contributions is amazing. And yet without fiscal union to accompany their entry into the monetary union with the rest of Europe, they could mismanage their public finances without any sort of accountability, except to the voter – who was hardly going to complain as they were as much a beneficiary of this as anyone.
“The length of this crisis boils down to two simple factors: how long the German voters are prepared to subsidise their Greek cousins, and how much pain the Greeks are prepared to take in order to preserve the capital bases of Northern European banks and that of the European Central Bank itself. And the ‘wiggle room’ in both factors is limited, and reducing fast.
“The pea-flicking that is supposed to pass for policy at the moment is not going to resolve anything and the market is demanding a resolution.
“The current discussions about bailouts and rollovers suggest that core Europe believes it can somehow pull Greece and its peers out of the hole. But that is wishful thinking. All the periphery countries are running deficits and will continue to do so, even with massive austerity programmes.”