The Greece game turns chaotic

By Felix Salmon
February 17, 2012

Back in 2010 the ECB started buying Greek bonds to try to prop up Greece’s debt markets. It did so in the open market, which meant that it was the highest bidder at the time; reportedly it paid somewhere in the region of 75 cents on the euro for each bond. They’re currently trading at about half that level, so when the bonds get their 50% haircut, it’s going to lose billions of euros, right?

Wrong. For one thing, as John Carney pointed out in January, it didn’t really spend money on those bonds, it just printed money. If Greece doesn’t pay the ECB back, the worst thing that happens is that the euro money supply gets expanded a little.

But for another thing, it turns out that the ECB had a little trick up its sleeve all along:

The national central banks in the euro zone are set to exchange their holdings of Greek bonds into new bonds in the run up to a private sector debt deal to avoid taking any forced losses, euro zone sources said on Thursday…

Sources said the process could start over the weekend, with one adding that the move was a technicality and that the new bonds would have the same terms as the original ones.

A technicality?! Ha! What’s happening here is many things, but it’s most definitely not a technicality. The ECB is taking its stock of old Greek bonds, which are worth very little and which are going to suffer a whopping great haircut next month, and swapping them out for shiny new bonds which Greece is going to pay in full.

This is no normal bond exchange: No one else gets this deal, and there are no tag-along rights for private-sector investors who might fancy the opportunity to do something similar. It’s a basic tenet of bond market that all bonds of a given series are equal and fungible, and that what happens to one happens to them all. But not here. You can fight about whether this bond is or should be pari passu with that bond, but it’s a no-brainer that any bond is pari passu with itself. Except in this case, it seems, where the ECB’s stock of Greek bonds have suddenly become senior to everybody else’s stock of the exact same securities.

On a conceptual level, it makes sense that the Troika — of which the ECB is a third — might be granted immunity from haircuts, in return for providing new money to Greece. On a legal and practical level, however, this is ugly — and you can be quite sure that it’s only going to get uglier from here on in.

Which brings me to the blog post of the month, from Daniel Davies, a/k/a dsquared. He’s structured the choices facing the Troika as a choose-your-own-adventure book; needless to say, none of the outcomes are particularly palatable, although some are definitely worse than others.

The point here is that given political realities, there is literally no real solution to the Greece problem. The market attempted some kind of rally on the ECB news today, which on its face is weird — if the ECB takes its bonds out of the restructuring pile, then that just means a bigger haircut for everybody else, if Greece is going to reach debt sustainability. But the rally, if it was related to the news at all, was probably just relief that something is being done — that plan beats no plan. Which is probably overly hopeful. There might be a plan here, but equally there might not: this could be a purely defensive mechanism, protecting the ECB from a chaotic Greek default.

The most notable thing about the news, for me, was the utter lack of eyebrows which were raised when it happened. Everybody’s expecting the unorthodox at this point, to the degree that when it happens, no one seems to care very much. Or maybe it’s just that no one has a clue what’s going on. I was at a very wonky dinner this evening, talking details of CDS determination committee protocols and the like, when it struck me that the politicians making the decisions here are not financial sophisticates; many of them like the idea of the CDS not being triggered just because they think that means Greece won’t have defaulted.

In short, expect things to get weird from here on out. We are entering a zone of probability distributions at this point, where actions stop having foreseeable consequences. No one’s really in charge, which doesn’t help. Greece has sophisticated and professional advisers, but Greece isn’t in control of its own destiny; the Troika is. And the various members of the Troika are no longer singing from the same songbook. The ECB has partially protected itself, with this move; but in increasing the amount of preferred-creditor debt that Greece has, it has also increased Greece’s debt burden and hurt the credit quality of the debt that Greece owes the IMF, which is also a member of the Troika.

Go play Daniel’s game: if anything it’s an oversimplified presentation of the various ways that the Greek crisis might play out in the next few weeks. There’s nothing in there, for instance, about tensions between members of the Troika, or about bondholders holding out with a blocking stake and complicating things that way. Then, once you’re thoroughly confused and depressed, put yourself in the position of a European politician who has to make real-world decisions with real-world consequences. And ask yourself how predictable your actions might be. The endgame is approaching; but the only thing we know for sure about it is that anybody who thinks they know how it’s going to play out is delusional.


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Felix, you are wrong to say that no body is screaming about this. FT Alphaville saw this coming months ago and has had several posts about why any bond swap that didn’t involve the ECB/Central Bank holdings was going to raise this exact problem. I expect there will be a post on FT about this today.

This is insane. Sovereign bonds come with some strange extra risks (funny they have been treated risk-free for so long). It’s a bit like playing monopoly with a cheater working the ‘bank’.

The real comedy is how anyone can believe Sovereign CDS. It’s always been a bit like buying meteorite insurance (insurance that only pays if the earth is destroyed by a meteorite). Now we are finding that the earth is certain to be destroyed, and to add insult to injury, the insurance doesn’t even work!

Posted by FinanceChicken | Report as abusive

Fascinating, Dude! I’m going to need a little more time to consider Daniel’s Gordian knot, but I still think the best thing for most parties is to end this whole arrangement.

Everyone should just take their lumps and end this game. Greece will then move in a direction that benefits Greece or or it won’t.

Posted by breezinthru | Report as abusive

I’m guessing someone on Elliott Associates’ speed dial has an opinion as to the legality of the ECB “swap” [theft] and whether or not you can appeal that decision to a EU court. I’m guessing that you can’t do this under any existing EU law, and that the national CB’s are not immune. Five years from now, the Anglo-Saxon speculators get a well deserved payout.

Posted by johnhhaskell | Report as abusive

I think the reason for the ECB wish to avoid default has more to do with the much larger number of Greek bonds that have been likely posted to it as collateral.

Exactly what happens when these bonds default? If the banks that hold them are marking to maturity and leveraged, its unlikely that the ECB will get much back at all.

Posted by santcugat | Report as abusive

The collateral argument doesn’t fly… Collateral continues to be the property of entity that posted it, it only changes ownership when a default happens.

To the extent that the ECB’s loans are current, the collateral does not yet belong to the ECB.

Of course as we can see from Felix’s excellent post, we have now entered a world where the rules of physics no longer apply!

Posted by FinanceChicken | Report as abusive

However, once a default happens, the bonds can can no longer be posted as collateral, and the bank wil have to come up with the cash from somewhere else very rapidly.

In the case of a voluntary exchange, the banks can continue to use the new bonds as collateral, since no default has happened.

Posted by santcugat | Report as abusive

“…and swapping them out for shiny new bonds which Greece is going to pay in full.”
How do you know?
This is a baseless claim, the ECB exchange just reduces the pool of eligible bonds for the restructuring swap and increases the odds that it will succeed. The ECB is specifically banned from the engaging in direct monetary financing so it was never on the agenda that it would participate in the PSI.
The new bonds it gets are exactly the same term and maturity and governing law as the old ones and in no way is the ECB protected if Greece eventually defaults.
As per the statutes, if these bonds pay off the profits will
be shared pro-rata as per the capital key of the member states as will losses if they don’t pay off.

Posted by alea | Report as abusive

“Or maybe it’s just that no one has a clue what’s going on”

I think this may be the best point of the article. Perhaps they are all just talking their book, but I’ve read way too many investing newsletters that simply sweep the current situation under the rug – “Greece is contained”, “Market has priced in Greece”, etc without any further analysis supporting that conclusion. Reminds me a bit of the early 2008 housing analysis, which was a much easier topic to grasp.

I certainly have no idea what’s going on once you start scratching the surface, as the entire process has become incredibly esoteric from a banking / sovereign financing standpoint. The structure of the euro certainly doesn’t help matters.

I’ll echo the sentiment above that FT Alphaville has been doing a great job of covering the nitty gritty, which makes you realize that Greece can’t be sorted out in a sentence or two.

Posted by djiddish98 | Report as abusive

If the ECB took the 50% haircut, it would mean that the balance sheet expansion would become permanent as the 50% would be a loss and no longer a loan. This is where the Germans have drawn their line in the sand. This agreement is no where near a solution. There will be a new crisis soon and ultimately a Greek default and exit from the euro.

Posted by gordo53 | Report as abusive

Completely off topic, but on a theme that Felix has touched often: 2/15/lowest-income-renters-left-behind-i n-housing-crisis/

Posted by TFF | Report as abusive

How can investors complain? They loaned to Greece, and the ECB and troika shored them up with a bailout. Look at the BIS quarterly reports on Greek debt. It’s been reduced because of the bailout. So, now the investors want everyone playing by the old rules? The old rules said you should have eaten your default instantaneously.

Come on!!!!

Posted by DanAllen | Report as abusive

While we’re at it, why don’t you check out our professional’s overview of the economic situation over at

Posted by Diablo3Guide | Report as abusive

While we’re at it, why don’t you check out our professional’s overview of the economic situation over at

Posted by Diablo3Guide | Report as abusive

DanAllen, the investors who benefited from the earlier bailout are not necessarily the ones who are holding the debt now. Different bonds, different maturities.

Posted by TFF | Report as abusive

Since we’ve known of Greece’s troubles for 2 1/2 years now, you’re telling me I’m supposed to be sympathetic for managers chasing insanely high returns in the last 2 years? They very well knew this was a risk because sovereigns can no longer backstop their banks. They’ve already stuffed as much private debt as they possibly could on the public. From here on in, anything goes. I thought everyone was aware of this.

Posted by DanAllen | Report as abusive

DanAllen, some institutions hold bonds for longer than 2.5 years… Those whose bonds matured over the past year were repaid with bailout money. They made out nicely. Those whose bonds did not mature are being asked to take a double share of the haircut.

Yeah, they probably should have sold the bonds at a loss when the troubles became apparent. I don’t feel particularly sorry for money managers of any stripe. Of course the money managers only share in the gains, not in the losses, so the money managers will be fine. Only their clients (e.g. pension funds) will be hurt.

Posted by TFF | Report as abusive

Hey, do the Asian Central Banks and Sovereign Funds get the same deal? I bet not…they probably own billions, right?

Posted by Fish88 | Report as abusive

Can we stop using the term ‘haircut’ in these cases? The first time I heard the term used in financial matters it meant ‘a little off the top’, taking a profit but leaving the basic investment more or less unchanged. What we’re talking about here is not a haircut but an amputation, and it would help if our language made that clearer.

Given that analogy, I suppose Felix is trying to prevent them using an anaesthetic!

Posted by Wainwright | Report as abusive

PSI and OSI with ecb participation is a must, there’s not enough money saved on the cut.


Posted by cnhedge | Report as abusive