What Is The PSI And What It Means for Holders of Greek Bonds – An Overview of the Initial and Modified PSI program

Following the Eurozone Summit on July 21st, European leaders worked out on a solution for the Greek sovereign debt problem, along with a new bailout package, proposing to private holders of Greek Government bonds a voluntary debt exchange program, with new longer-maturity-bonds and a 21% haircut on their nominal value.

In late August, the Greek government revealed more details on the process, recognizing that without the voluntary debt restructuring, the ability to meet future obligations, it would become problematic. Although it was clarified which bonds will be included in the exchange program (see diagram below), as well as the proposed options for the Greek Bond Holders, the PSI (Private Section Involvement) program failed to materialize, mainly because of the deterioration of the financial situation of Greece and the indecisiveness of EU politicians to reach a common agreement on the actual handling of the oveall debt problem in the area.

On the 26th of October, EU leaders came up with a modified PSI program, much more realistic than the initial one and it remains to be seen if this time it will go through and get executed.

In this article we explain the details and implication of the initial PSI program and then we overview the modified PSI, decided on the 26th of October.

The 4 options of the (initial) PSI

In the initial design of the PSI program, there were four options, with the first two relating to an exchange of 100% of the nominal value of Greek government bonds and the remaining 2 choices requiring a 21% “haircut” on their nominal value. Apart from the fourth option that was offering an exchange of old debt with the acquisition of a 15-year, 6,20%  fixed rate coupon bond, all the remaining options required the exchange of old bonds with new ones, with average maturity of 30 years.

Which part of the Greek debt is included in the PSI?

The diagram above shows the total amounts that were planned to be included in the  PSI program, based on the original design. Given the ECB’s statement that it will not participate to any exchange program, the PSI was referring only to Greek debt holders besides the ECB, with total capital in Greek bonds of about 60bln for the period 2011-2014 and 90bln for the period 2014-2010.To activate the program, the Greek government had required 90% as a minimum participation, i.e. they anticipated the acceptance of bond exchange of total amount 135bln [90%(60+90)]until 2020, hoping that a significant proportion will choose to proceed to an exchange of bonds, with a 21% haircut (getting higher coupon in return), something that didn’t happen.

The biggest part of these debt is in Greek and European banks’ hands (see in detail the following list of the largest holders of Greek bonds), and that’s one of the reasons for the sharp drop of their stock prices for the past months.

Most private investors chose to go with the first option of the PSI, stating that they are willing to exchange the present issues with new ones, of 30-year-maturity, avoiding the choices that included the 21% haircut.

The new PSI, as it was decided on 26/10, 50% Haircut for Greek Debt Holders

During the Summit of 26/10/2011, EU leaders decided on a series of new measures, to ensure the viability of the Greek debt, but also the overall normalization and convergence of European economies. Among these, lies the decision for a modified PSI for Greek Bonds, requiring a voluntary “haircut” of 50% on the nominal value of Greek Bonds.

The “haircut” of 50% in the value of bonds, automatically makes necessary the recapitalization of the European banking system, which is why the EU leaders have agreed to strengthen the EFSF (European Financial Stability Fund) with more funds. The funds of the EFSF will now reach 1 trillion in an effort to stabilize and support the weak sovereign countries. The Eurozone countries will contribute to the new PSI with total capital of 30bil million, with further potential funding until 2014 of extra 100billion euros.

So, which bonds will get a “haircut”?

Regarding Greece the proposed haircut concern issues of about 200bln (including all maturities, even beyond 2020), still excluding though the bonds owned by the ECB. It is not certain though that all private sector’s holders will participate in the modified PSI and the first estimations talk about volunteer participation rate of 50-70%. The 15-page statement of European leaders was fairly vague and does not get into details on several topics, which may be the “thorns” in the implementation of new decisions. It is noticeable that neither for Greece, nor the rest of the eurozone, there exists an explicit mention of development measures to be taken in order to end the crisis, but only general references on that matter.

If I am an individual holder of Greek Government bonds, do I have to join the modified PSI?

Private investors who chose to invest part of their savings in Greek government bonds, it is probable that they will not be affected by any haircut that may occur. The PSI refers to the voluntarily acceptance of bond exchange+haircut by  banks, pension funds, and insurance companies. Still, we need to be cautious on that because there is huge distance from the political decision to the actual implementation of such programs.

UPDATE: The Greek government voted ex-post the inclusion of CACs (Collective Action Clauses) forcing the majority  of Greek government bondholders to accept the haircut of 53,5% in the nominal value of their bonds. There is a huge ethical issue with that decision and a lot of the private individual are taking Greece to  courts.

When will the modified PSI eventually get implemented?

It is estimated that the implementation of the final program of PSI can be held in early 2012. But first, it is necessary that EU leaders agree and clarify the precise terms of exchange and strengthen the support mechanism in the Eurozone. European leaders stated that they are determined to give a solution, but there is still a long way to the effective implementation of decisions of October 26th and certainly, there is no time for celebrations for Greek Politicians.

The new PSI provides significant liquidity to Greece, but there are many details to be clarified and doubts regarding needed growth measures, the effectiveness of tax administration, spending cuts and the success of privatizations. All these are structural reforms that no Greek government managed to achieve until now, so it remains to be seen if the current one will succeed. The distribution of the Greek debt has changed a lot since the beginning of the sovereign crisis (see an earlier post , where I describe and actually forecast this re-distribution) making it much harder for Greek politicians to negotiate the terms of any future bailout package.

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12 thoughts on “What Is The PSI And What It Means for Holders of Greek Bonds – An Overview of the Initial and Modified PSI program

  1. Mr. Leimonis,

    First of all, articles like yours are trully beneficial and help the greek citizens understand the real situation. Keep up the good work and do not forget that many people admire your work.

    Secondly, I would like to ask you as regards the ‘defeasance’ mechanism, mentioned in the Greek Government statement (26 of August). I have read the statement, however, I must say I do not fully comprehend the procedure (who will be the trustee etc). I would be grateful if you could throw some light on this issue, which I believe is of great importance, yet not adequately explained to the Greek citizens.

    Thank you in advance.

  2. Pingback: What Is The PSI And What It Means for Holders of Greek Bonds - An Overview of the Initial and Modified PSI program - Financial Arena | #GreekCrisis | Scoop.it

  3. Can you please further explain what is the PSI benefit to the Greek banking system?

    It would appear to me that both Greece and its banking system are net losers from the the PSI.

    The PSI is a Teutonic idea designed to shift burdens which mostly belong to Germany and the ECB onto private shoulders.

    To put it bluntly, its a cheap Germany that refuses to do what needs to be done because of a 1929 pervasive phobia and Merkel’s incompetence in matters of modern finance.

    Why would Greece alone consider the PSI (which was dropped as a mechanism for all other Eurozone members on 12/09/11) when in the future there might be much more efficient choices to cure the problem?

    The PSI is the equivalent of asking to pay for the surgery of an injured person through that person’s amputation or removal of organs to be sold in order to cover the expense of the surgery. It simply does not make any sense.

    • I agree with you on the non-effectiveness of this plan and time will prove it very soon that it will not benefit Greek people. Without a well-organized plan to restructure the economy and focus on its growth potential, all these austerity measures required in order to approve the PSI and any other cash infusion, will just end up to a great damage of the Greek economy. Banks might have some benefit as they might escape their nationalization and whatever this means for the lucrative salaries and perks that some people get even today…

  4. Good morning Mr.Leimonis.
    Are there any news about the involvment of individual retail bondholders in greek swap?When it’s said about 200 bln Euro and a necessary “nearly universal acceptance” of the deal, what does it mean?And how much is it worth the greek debt in hands of the institutions belonging to, or represented by the IIF ?If greek government will change low and will put CAC in existing bonds, does it mean that individual bondholdres will hav to take to a hit?And-last thing,sorry- is a CAC is put in greek existing bonds, how can bonds belonging to ECB not be involved in the deal?Doesn’t exist for greek law any “equal treatment of creditors”?Thank you.

    • Dear Anselmo,

      although a bit late and most is history, i wanted to reply on your questions as sometimes such technical topics seem. Individual retail holders of Greek government bonds were forced to accept a very damaging deal although Greek politicians speculated with these unfortunate investors. They did create some kind of class-action and will go against the Greek Republic but I am not sure of its effectiveness.
      The law for CACs was voted just at the last minute and it is at least unethical to perform such a haircut to an individual that bought the bond on it issuance or at the secondary market near par.
      ECB holdings were excluded because they are the sole providers of liquidity to the system and just can do such a thing. still not ethical especially since they make gains from the rate differential.
      i will upload an analysis i wrote on the final PSI and I hope it clears all remaining question you had.
      the debt problem is pan-european and only a political decision can give a solution.

  5. “A 30-year low interest-rate loan to Greece could accompany the reversal of PSI (private sector involvement) to keep the financing cost on the Greek government as low as presently contemplated,” Orphanides, a member of the European Central Bank governing council, said in an article in the Financial Times.

    Orphanides said the end of 2011 saw questions raised about the survival of the euro that would have been considered taboo earlier.

    “What caused this dramatic erosion of confidence? Was it the result of fiscal profligacy, such as that revealed in Greece that marked the start of the slide? Was it the loss of competitiveness? Or current account imbalances?” Orphanides said.

    He said these were contributing factors but the eurozone also suffered from a broader problem: the incomplete design of the euro area – lax monitoring, inadequate enforcement of the rules and non-existence of a crisis management framework

    “It also points to the collective failure of eurozone decision makers to tackle this problem effectively. A failure that has been marked by a sequence of EU summits and aborted plans that have convinced some that a solution is beyond reach,” Orphanides said.

    He said two decisions proved costly for the eurozone: first, European leaders agreed to impose losses on creditors whenever a member state faced liquidity concerns.

    “The message to potential creditors was clear: eurozone sovereign debt should no longer be considered a safe asset with the implicit promise that it would be repaid in full. Private sector involvement (PSI) was the new doctrine.”

    And second, at the EU summits in July and October, European leaders decided to force losses on holders of Greek debt.

    The Greek PSI reinforced the idea that holders of eurozone sovereigns should be prepared to incur losses even under circumstances that would not necessarily trigger comparable losses for sovereigns outside the eurozone.

    “Unsurprisingly, as investors digested the implications of the two decisions they increasingly fled eurozone sovereign markets,” Orphanides said.

    The resulting contagion was evident in the deterioration of borrowing conditions for other eurozone member states after October 18 2010; July 21 2011 and October 26 2011.

    EU leaders have since reversed the PSI innovation but still failed to restore investor trust.

    A reason cited for this is that the December decision did not reverse the haircut on Greek debt. Rather, the eurozone leaders supported continuing the Greek PSI while stating that the Greek case was unique and would not be repeated.

  6. Time to jettison the plans to hit Greek creditors

    By Athanasios Orphanides

    Government debt markets are about trust. Before the crisis, all eurozone governments enjoyed the benefit of their collective trustworthiness, co-operation and solidarity in the form of favourable financing conditions that contributed to the wellbeing of Europe.

    Investor trust in the eurozone has been badly shaken in the past two years. The image of co-operation and solidarity has been shattered. As 2011 came to a close, questions about the survival of the euro that would have been considered taboo earlier began to surface. Following Greece, a number of member states faced difficulties refinancing their debts or lost access to markets altogether, despite the implementation of unprecedented fiscal programmes.

    What caused this dramatic erosion of confidence? Was it the result of fiscal profligacy, such as that revealed in Greece, that marked the start of the slide? Was it the loss of competitiveness? Or current account imbalances? Without doubt, all these were contributing factors. But the contagion that has spread to so many eurozone member states points to a broader problem: the incomplete design of the euro area – lax monitoring, inadequate enforcement of the rules and non-existence of a crisis management framework. It also points to the collective failure of eurozone decision-makers to tackle this problem effectively – a failure that has been marked by a sequence of EU summits and aborted plans that have convinced some that a solution is beyond reach.

    Two related decisions proved costly for the eurozone. First, following the summit in Deauville in October 2010, European leaders agreed to introduce a novel element in eurozone sovereign markets: the imposition of losses on creditors whenever a member state faced liquidity concerns. The message to potential creditors was clear: eurozone sovereign debt should no longer be considered a safe asset with the implicit promise that it would be repaid in full. Private sector involvement (PSI) was the new doctrine. Second, at the EU summits in July and October, European leaders decided to force losses on holders of Greek debt. The Greek PSI reinforced the idea that holders of eurozone sovereigns should be prepared to incur losses even under circumstances that would not necessarily trigger comparable losses for sovereigns outside the eurozone.

    The decisions that raised the cost of financing in the eurozone by introducing additional risk on private investors were not without a useful purpose. The PSI risk raised (disproportionately) the cost of financing of member states with larger projected levels of debt. Thus, it would serve as a disincentive to fiscal profligacy, thereby guarding against moral hazard and reducing the risk of future crises. Adding PSI risk could improve governance.

    Unsurprisingly, as investors digested the implications of the two decisions they increasingly fled eurozone sovereign markets. The resulting contagion was evident in the deterioration of borrowing conditions for other eurozone member states after October 18 2010, July 21 2011 and October 26 2011.

    The capacity to learn from mistakes is a hallmark of good leadership. As the existential threat to the eurozone became clearer, EU leaders changed tack. On December 9 a change in doctrine reversing the Deauville PSI innovation was announced. In future, the eurozone would adhere to International Monetary Fund principles. Leaders also agreed on a new “fiscal compact” to enhance governance.

    Unfortunately, despite reversing the Deauville PSI innovation, investor trust has not been regained. A reason cited for this is that the December decision did not reverse the haircut on Greek debt. Rather, the eurozone leaders supported continuing the Greek PSI while stating that the Greek case was unique and would not be repeated. But can the promise to abandon the PSI doctrine in the future be convincing while losses on Greek debt are imposed at present?

    Reversing the Greek PSI decision would help to restore trust. Could it still be undesirable? Consistent with IMF principles, one of the reasons for imposing the Greek PSI was to reduce the interest burden on the Greek government. But a serious limitation of their application in the eurozone is that the IMF principles examine a member state in isolation, ignoring contagion effects on other states. Reversing the Greek PSI decision would also raise the financing cost on the Greek government, but by restoring trust in the eurozone it would reduce the financing cost of other eurozone governments. Reversing the Greek PSI would benefit the eurozone as a whole. A 30-year low interest-rate loan to Greece could accompany the reversal of PSI to keep the financing cost on the Greek government as low as is presently contemplated.

    The key is to restore trust.

    The writer is governor of the Central Bank of Cyprus, a member of the ECB governing council and member of the ESRB steering committee

  7. I agree with Dean, it’s primarily about trust. Trust means that the risks are understood and believed. Without trust, buying bonds is like putting your money on the black.

  8. Well, we now know that even attempting (let alone subscribing to) the PSI has lead to a selective default. In other words all the attempts by Greek politicians to avoid bankruptcy were for nothing. And please, let’s not debate the technical side of a selective default. If it looks like duck, walks like a duck and quacks like a duck, it’s probably a duck.

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