Greece: What happens if bondholders hold out?

By Felix Salmon
January 25, 2012

What happens if Greece puts forward an exchange offer which is acceptable to the Troika (the EU, ECB, and IMF), but unacceptable to bondholders — and only say half of them accept? In that event, there wouldn’t be nearly enough acceptances to be able to bail in the holdouts — and as a result, Greece would be paying out on its new bonds and would be forced to default on the old bonds which weren’t tendered.

Narrowly speaking, this would be good for Greece’s fiscal situation. After all, if it’s only making coupon payments on half of its private-sector debt, that saves it a substantial interest expense. But there’s no sense in which Greece actually wants this outcome — for two reasons.

Firstly, even if the ECB encouraged Greece to offer bondholders a very low coupon, it also doesn’t want Greece to be in indefinite default. Some kind of technical default which lasts for a couple of weeks, before the new bonds are accepted? That’s fine. But a protracted legal fight with bondholders trying to attach Greek assets around the world, and waving Greek obligations which are going unpaid? The ECB certainly doesn’t want that. It might be accepting just about anything as collateral these days, but even the ECB might well draw the line at lending against securities issued by a government which is clearly not paying a huge chunk of its debt.

The IMF, too, has rules against lending into arrears: it won’t lend new money to countries which are in default on old loans. This is a self-imposed rule which the IMF has broken many times, and might well break again, if it can say with a straight fact that Greece made a “good-faith effort” to keep current. But still, the bigger the number of holdouts, the harder it becomes for the Fund to continue to lend money to Greece.

The most devastating effect, however, would probably be on Greek banks. The obligations of Greek banks, pretty much by definition, are less safe than the obligations of the Greek government. Deposits in Greek banks are obligations of Greek banks. And so anybody with deposits at a Greek bank would likely move those deposits somewhere much safer, like Germany. That capital flight would weaken the balance sheets of the Greek banks and force the ECB to make a hard decision about lending not to Greece itself but rather to Greece’s banks. And even if the ECB did prevent Greece’s banks from going bust (certainly the Greek government doesn’t have the money to do that), those banks would be much weaker, much smaller, and much less willing to provide credit to Greek businesses. The Greek economy would surely be severely damaged as a result.

So it’s important, before March 20, that Greece puts together an exchange offer which a significant supermajority of bondholders will accept. It doesn’t need everybody to accept — there will be holdouts, especially when it comes to bonds issued under foreign law. But so long as those holdouts are obviously in the minority, that’s probably survivable. But Greece does need to be able to bail in all of the holders of its domestic-law bonds. Otherwise both the legal dynamics and Greece’s broader economy could become very nasty indeed.


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The difficulty with agreeing any Greek voluntary default is that 90% of all Greek bonds are issued under Greek law and they contain no Collective Action Clause allowing for a supermajority to over rule a minority of dissenting bondholders. The Greeks could retrospectively pass a CAC but it appears clear the ISDA would have to rule the triggering of this to be defaulting credit even. Hence it isn’t clear how the Greeks can compel all bond holders into a voluntary agreement. Forty percent of bondholders, such as the ECB, claim to be public bondholders and as such they refuse to take a haircut and if another minority of private bondholders, with CDS protection we can assume also dont want to get involved, then why would other bondholders act as suckers and get a 70% haircut. I suspect the market will call the bluff on this and the EU-IMF-ECB will invent some fudge to get around he mid March deadline.

Posted by TheSweeney | Report as abusive

The Greeks can use the Australian option: pass a law that says that payments on the existing bonds are to be taxed at 70%, withheld at the source.

There is no need to negotiate with the vulture funds, and the funds themselves are figuring that out.

Posted by klhoughton | Report as abusive

How does Greece raise any additional money in the markets after they pass this brilliantly conceived “Australian option”? “Trust us, we probably won’t do it again”?

Posted by johnhhaskell | Report as abusive

Treating an identical bond differently based on the holder (ECB vs. private) is a terrible idea, both philosophically and practically. Let’s see how fast private holders dump bonds in future instances of the ECB acquiring significant holdings of sovereign debt.

Posted by realist50 | Report as abusive

Der Spiegel had a better twist on trimming the unruly hedges into shape ( ope/0,1518,811295,00.html)

(quote) The strategy does have one snag. The hedge funds assume that in the event of a payment default all CDS providers can pay. That is by no means certain, though. The CDS papers are distributed opaquely throughout the financial system. No one knows for sure who holds them at a given time, and who, in the end, will be responsible for them …. Under that scenario, it would also likely affect the hedge funds.

snip snip snip where it hurts – in the gambler’s pockets

Posted by scythe | Report as abusive

Instead of trying as hard as possible to avoid the label of a credit event, Greece would be better advised to simply announce it as such. Why go to great lengths to make sure that your bondholders’ counterparties don’t have to make good on their contracts? Doesn’t make any sense to give a significant haircut to your creditors and try to do it in a way that makes it even more painful for them. If this situation isn’t exactly what the CDS product is for, then what is?

Posted by Eric377 | Report as abusive

Eric377 – I agree with you, and the possible answers would be either (1) an ideological opposition to CDS as “speculation” or (2) a fear that paying out on CDS would cause financial distress to banks. Commentators – I think including Felix – have pointed out that (2) is extremely unlikely based on what’s known about the relatively small amount of Greek sovereign CDS that has been written. In either case, it’s yet another reason that I think we’ll see a “lack of sound contractual law” risk premium on peripheral Euro-zone sovereign debt for years to come.

Posted by realist50 | Report as abusive