Opinion

Felix Salmon

Greece’s endgame looms

By Felix Salmon
January 18, 2012

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.

Comments
16 comments so far | RSS Comments RSS

“Europe’s biggest banks have quietly sold their holdings of Greek debt to aggressive hedge funds.”

…who have most likely borrowed money from those same big banks for precisely that purpose. I’m skeptical whether these sales do anything to reduce their exposure to that Greek debt. Certainly the risk to the overall financial system won’t have changed much.

Posted by TFF | Report as abusive
 

All this of course runs completely contrary to the advice of the fellow (Mario Blejer) who oversaw Argentinia’s default. His advice to Greece some time ago was to default big and at one time, not in driblets over time. You don’t jump across a chasm in two leaps, I recall his saying.

Posted by Chris08 | Report as abusive
 

@ Felix,

I think Coy is saying that you will swap a 100 euro dollar face value in old debt for 50 euro face value of new debt. That new debt will trade at about half its face which makes sence since the issuer just defaulted. So that’s the shockingly large 75% haircut you laid out in a previous peice. Add in the 15% rescue payment from the ECB, IMF, and EU and that gets you to 40 cents on the dollar which is roughly where the bonds are trading today.

The thing I don’t understand yet is what are the French and Germans getting for the 15% they are kicking in? They get to keep the Greeks in the Euro? How does that help them exactly? It’s like I owe 100k on my credit cards… I can’t / don’t wish to pay… so I ask my parents / friends to kick in 15% of what I owe. If they agree then I’ll pay off 25% of what I owe and if they don’t then screw it I’ll walk on the whole debt.

Can anyone out there explain the logic behind the 15% rescue payment?

Posted by y2kurtus | Report as abusive
 

Back to the Middle Ages for the Greeks.
Nice people but not too bright.

Posted by sillysteve | Report as abusive
 

It’s ~$18 billion we’re talking about? The fate of the European economy hinges on whether or not Greece defaults on $18 billion? How much money will be lost if there is a default? A lot more than $18 billion, I would guess. It will probably drive the US stock market down, lowering the market cap of all the publicly traded equities by ten times that amount, or more, not to mention the losses in real estate. It will make the dollar and U.S. exports even more expensive. But we can print those dollars with impunity, because people are afraid of holding euros, and they don’t really want yen, and the pound is too connected to Europe’s economy. So maybe we should just print up an extra $18 billion and pay off the damn bonds. Will anybody even notice?

As for the terms of whatever deal they work out, it doesn’t matter, the only thing that matters is that there is a deal. Any deal. Those people trying to work out a deal are politicians, and like the politicians in the U.S., they just want to be able to say they made a deal, and they worked hard, so that when they retire, something will be name after them, and they can say they really are proud of their years of public service. Solving a problem is just a nice-to-have, not a must have, so don’t count on that happening.

Posted by KenG_CA | Report as abusive
 

KenG_CA

You are right, the whole problem is that $18 billion which is right in front of your nose. Greece has no other problems. Italy has no other problems. Spain has no other problems. The German banking system is soundly capitalized. It’s a one time payment of $18 billion and all your troubles are gone.

Posted by johnhhaskell | Report as abusive
 

KenG_CA

You are right, the whole problem is that $18 billion which is right in front of your nose. Greece has no other problems. Italy has no other problems. Spain has no other problems. The German banking system is soundly capitalized. It’s a one time payment of $18 billion and all your troubles are gone.

Posted by johnhhaskell | Report as abusive
 

KenG_CA, yes, that would certainly do the trick if The Fed and/or Treasury “just” printed up an extra $18 billion and pay off Greek bonds. And the next day, you could find Tim Geithner’s head on a pike just outside of Zuccotti Park, if you could make your way through the clouds of tear gas and phalanx of policemen in full riot gear.

Posted by Strych09 | Report as abusive
 

johnhaskell, there are problems beyond the $18B in bonds that are on the verge of default, but that seems to be the only one that is being addressed anyway. There was no mention of Spanish or Italian debt, or the German banking system (btw, the EU can print euros just as easily as the US can print dollars).

I don’t expect the US to cover that loan, I’m just trying to put it in perspective. It’s not a big number compared to what the US has been dedicating to keeping our economy from imploding, and the EU’s economy is bigger than the US economy. The cost of failing to resolve the debt issues is far greater than the amounts that are in danger of default.

Posted by KenG_CA | Report as abusive
 

“And the next day, you could find Tim Geithner’s head on a pike just outside of Zuccotti Park, if you could make your way through the clouds of tear gas and phalanx of policemen in full riot gear.”

Optimist.

Posted by klhoughton | Report as abusive
 

“the EU can print euros just as easily as the US can print dollars”

Not true — they serve too many different masters, with distinct interests. That is part of the problem.

Posted by TFF | Report as abusive
 

TFF, and the U.S. doesn’t have too many different masters and distinct interests? The US government almost defaulted because of a small handful of economic terrorists were making demands that were unacceptable to the majority of the nation, and their political leaders deferred to them. We have 50 states, they have 17. I don’t think it’s any worse.

Posted by KenG_CA | Report as abusive
 

Suppose it is a matter of opinion, KenG, but I believe the US is closer to being a full fiscal and economic union than Europe is.

Posted by TFF17 | Report as abusive
 

TFF, no question, we are more integrated fiscally and economically, but not politically, and the obstacles to solving the problems are mostly political.

Posted by KenG_CA | Report as abusive
 

To reduce the fear factor, it seems a systemic event is unlikely because of the small scale of outstanding greek cds coverage ($4 billion). People lose money, but it’s basically capped at the value of the haircut plus the probability of a bank failing as a result. Plus the probability that an unregulated derivative that isn’t a cds is triggered.

Posted by greengroup | Report as abusive
 

Cmon… Greece and the EU will kick the can down the road. They changed the rules before, because they made the rules. They will change them again! Default is not a DEFAULT! no CDS, youre screwed!

Posted by marantz | Report as abusive
 

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