## Greece’s endgame looms

January 18, 2012
big deadline in Greece is March 20 -- that's when the country has a €14.4 billion bond maturing that it can't afford to repay.

The big deadline in Greece is March 20 — that’s when the country has a €14.4 billion bond maturing that it can’t afford to repay. So Greece and its creditors are playing chicken with each other right now. Both want to do a deal, which would involve a cash payment of about 15 cents on the euro being paid out by a rescue committee comprising the EU, the IMF, and the ECB. Existing bondholders would get shepherded into new debt which would be worth less than the old debt but at least would remain current, while Greece would avoid the parade of horribles associated with a “hard default”, with its banks retaining access to funding from the international community in general and the ECB in particular.

The logical outcome, then, is that a deal gets done — probably along the lines that Marathon Asset Management CEO Bruce Richards sketched out to Peter Coy today. Richards’s math is a bit hard to follow:

The new bonds will probably pay annual interest of 4 percent to 5 percent and have a maturity of 20 years to 30 years, Richards said. They may trade for about half of their face value, he predicted. Altogether, the net present value of the deal for the bondholders will be about 32 cents on the euro, he estimated.

This doesn’t add up: if face value is 50 cents on the euro, then half that would be 25 cents; add in 15 cents of cash, and you get a total of 40 cents on the euro, not 32.

Update: OK, I understand how the math works now. The headline 50% haircut includes the 15 cents in cash: it’s 35 cents in bonds plus 15 cents in cash for a total of 50 cents. If you value the 35 cents in bonds at 50 cents on the dollar, then the bonds are worth 17 cents; add that to 15 cents in cash, and you get a total of 32 cents. Note that Greece, in this scenario, is getting a 65% face-value haircut, rather than a 50% haircut, and is getting coupon relief as well — all in all, Greece is swapping bonds it issued at par for new instruments worth 17 cents on the dollar. Which is an 83% NPV haircut. You can see why the market might object to a haircut that big.

But either way, the market is saying that a deal along those lines isn’t going to fly. The March 20 bonds are currently bid at 42, offered at 44, and no one is going to accept a deal worth 32 cents or even 40 cents if you can just sell those bonds outright for 42 cents. And similarly, no one buying the bonds right now at 42 is going to accept any deal at 32.

And it’s much harder to reach a deal now than it was a few months ago, because many of Europe’s biggest banks have quietly sold their holdings of Greek debt to aggressive hedge funds.

Even if a deal is done, remember that the people sitting on the other side of the table are the IIF, the hapless and toothless trade body representing the big banks without really being able to commit them to anything. And if the IIF can’t deliver the banks, it certainly can’t deliver the hedge funds, which are much less susceptible to arm twisting moral suasion.

As a result, we’re not going to see all \$14.4 billion of bonds tendered in to any exchange — and there’s an extremely high chance that there will be enough holdouts to trigger Greek CDS contracts. That’s not the end of the world, although many people seem to think it would be; Greece is defaulting, so it stands to reason that default swaps would be triggered.

My expectation is that there will be an exchange; that it won’t be particularly successful; that it will trigger CDS; but that all the same it will be good enough for the EU, which will stump up its €30 billion and keep the can going on its bumpy path down the road. A bunch of hedge funds will be left with a large amount of defaulted Greek debt, and will start all manner of litigation, which will go nowhere for the foreseeable future. And no, there’s no way that Greece will pay those hedge funds just so that it can avoid the CDS being triggered.

Richards will be fine: he’ll tender into the exchange, get the cash and the bonds he’s expecting, and probably sell them at a small profit. Banks who lent to Greece at par will have to take very large losses. And the holdouts will start complaining loudly about the sanctity of contracts to anybody willing to listen, which will be a very small group of people indeed.

Frankly, it’s taken much longer than I thought for the actual default to arrive — seeing as how it was clearly signalled by Greece as long ago as July. That default would have been positively painless compared to this one. But at least we have a date, now. Greece will officially default on March 20. The only question is whether the EU will continue to fund the country after that date. For the sake of the euro zone, we had better all hope the answer is yes.