Many thanks to Van Tsui and Scott Barber for putting this chart together for me. We’re all used to seeing yield curves — charts which show the yield, for any given credit, at various points along the maturity spectrum. This chart is different: it’s a price curve. It just shows the price at which Greek bonds are trading, plotted according to their maturity.
And it’s really odd.
To understand just how odd this chart is, it’s important to realize that in the Greek bond exchange, there’s only one menu of options for anybody holding a Greek bond. It doesn’t matter if your bond is maturing in six months or if it’s maturing in 26 years, the instruments you’re given the choice of swapping into are all exactly the same.
The way that the bond exchange has been structured, the new Greek bonds are all going to trade at roughly the same price, at least in the first instance. If they didn’t, then everybody would simply pile into the most valuable instrument. We won’t know exactly what price they’ll be trading at until they start changing hands, of course, but I’ve marked a range between 62 and 75 cents on the dollar in the chart. At 62 cents on the dollar the bonds would be trading at an exit yield of 13%; at 75 cents on the dollar they would be trading at an exit yield of 9%. Chances are, when the bonds start trading, they’ll be somewhere in that range.
For the bonds which are trading at or near that range, the exchange makes sense. You swap one bond for another bond worth pretty much the same amount, and Greece gets a bailout at the same time. Net-net, you’re better off.
But for bonds trading significantly above 75 cents on the dollar, there’s a lot of reason to stay out of the exchange. We’re talking the bonds maturing in the next year or two here — for them, you’d be much better off holding them to maturity, or even just selling them on the secondary market.
Odder still are the bonds trading at very low prices, below 40 cents on the dollar, or, in some cases, below even 10 cents on the dollar. What on earth are they doing down there?
All of those bonds can be tendered into the exchange for new bonds which are likely to be worth at least 60 cents on the dollar: it’s free money. Just buy a long-dated low-coupon Greek bond, tender it into the exchange, sell your new bond, and double your money. Why hasn’t that price difference been arbitraged away? And, more generally, why aren’t the blue dots all arrayed in a nice straight line at roughly the level the market expects the new bonds to trade at?
I suspect that what’s going on here is that we’re seeing artifacts of an extremely illiquid market. Over the past year or so, as the Greek fiscal crisis got steadily worse, mark-to-market bond investors sold their bonds to banks, who were willing to pay a premium for them, partly because they were eligible to be used as collateral at the ECB. And the banks are holding on to their Greek bonds now, promising to tender them into the exchange. As a result, there’s no real liquid market in Greek bonds any more, and the prices seen in this chart aren’t available to any old bond investor looking for a quick flip.
Embedded in that mechanism is an implied quid pro quo. The banks will make a lot of money, at least on a mark-to-market basis, by tendering their long-dated Greek debt. In return for that profit, they will tender their short-dated Greek debt as well, even though doing so doesn’t make a lot of rational sense.
This helps explain why the official description of the bond exchange splits the par bond into two seemingly identical parts: a “Par Bond Exchange” where bondholders get a new 30-year bond with a step-up coupon rising from 4% to 5%; and a “Par Bond offered at par value as a Committed Financing Facility,” where bondholders roll maturing bonds into exactly the same thing.
Why make a distinction between the Par Bond Exchange and the Par Bond offered at par value, when both involve swapping your old bonds for the same new 30-year bond? Because the second one, the Committed Financing Facility, can be spun by the banks as them putting new money into the deal. And in a certain sense they are: they’re voluntarily giving up the extra money they could get by holding or selling their short-dated Greek debt.
All of this is in one sense much more complicated than it needs to be. Why construct a hidden and implicit quid pro quo, when you could do a normal bond exchange instead, and swap existing debt into new debt of similar or slightly higher value? Greek bonds, as the chart clearly shows, are worth anywhere from 10 cents on the dollar to 110 cents on the dollar: why should they all be swapped into the same thing?
On the other hand, this is at heart an old-fashioned London Club debt restructuring, as opposed to an Argentina- or Ecuador-style bond exchange. Bondholders look at their holdings on an instrument-by-instrument basis, while bankers are more prone to thinking about their exposure to any given credit as one big risk to be restructured.
So this exchange might well work, insofar as Greece’s debt is overwhelmingly held by banks. But don’t think of it as a template for future restructurings.