Felix Salmon

Greece’s bond exchange: it’s official

Felix Salmon
Feb 24, 2012 18:32 UTC

If you go to the official website for the Greek bond exchange, greekbonds.gr, you can now find an actual official document! The rest of the website, it says, “will be available shortly”, whatever that’s supposed to mean.

The document gives us most — but not all — of the information that bondholders will need in order to be able to decide whether or not they’re going to tender their bonds into the exchange. It’s written in very dense legalese — the first sentence is 70 words long, with only one comma — so let me try to pull out the important bits.

This is complicated, as you might imagine. It makes a significant difference (a) what bonds you hold, whether they’re Greek law or English law, and also (b) where you live, whether it’s in Europe or in the US. (There are also, it turns out, Swiss-law bonds as well, which have their own very special treatment.) But at the end of the day, most bondholders are going to get pretty much the same things when they tender their bonds; you’ll forgive me for ignoring some of the more niggly stuff.

Firstly, they’re going to receive new Greek bonds, maturing in 2042. It doesn’t matter whether the bonds you’re holding mature on March 20, or whether they mature in 30 years’ time — everybody gets the same new long-dated bonds, according to the face value of what they now own. In other words, the value of Greek bonds right now is wholly a function of what their face value is, and has nothing to do with their coupon or their maturity date.

The new Greek bonds have a step-up coupon: 2% through 2015, then 3% through 2020, then 3.65% in 2021, and then 4.3% from 2022 through 2042. Bondholders will receive new bonds with a face value of €315 for every €1,000 of old bonds they hold. (Again, remember that it’s face value which matters here, not market price.) What’s the market price of the new bonds going to be? Not very much; my guess is that they’ll trade at roughly 40% of face value. Which means that the “NPV haircut”, as far as the new Greek obligations are concerned, is somewhere on the order of 87%.

But bondholders will get more than just Greek bonds; they will also get new EFSF notes. The new EFSF notes come in two flavors: one-year notes and two-year notes; their face value is going to be 15% of the face value of the tendered bonds. The working assumption right now is that they’re going to be worth €150 for every €1,000 of bonds tendered: in other words, if you look at the value of what bondholders are going to be receiving in exchange for their bonds, it’s going to be split roughly 50-50 between Greek bonds and EFSF notes.

We don’t know that for sure, however, because for reasons I don’t pretend to understand, the coupon on the EFSF notes is still undetermined; we’re just told that it will be revealed on the Issue Date. (And no, we’re not told what the Issue Date is going to be.) In any event, bondholders in the US won’t receive EFSF notes at all; instead, they’ll receive “the cash proceeds realized from the sale of the EFSF notes they would otherwise have received”.

Finally, bondholders will receive GDP warrants of some description, which are the vaguest thing of all. “The GDP-linked Securities will provide for annual payments beginning in 2015 of an amount of up to 1% of their notional amount in the event the Republic’s nominal GDP exceeds a defined threshold and the Republic has positive GDP growth in real terms in excess of specified targets.” How much are these warrants going to be worth? The working assumption has to be zero, at least until we get some numbers for the minimum GDP and GDP growth that Greece needs in order to pay out on them.

When bondholder tender their old bonds to receive new ones, two things will happen. First, the old bonds will have been accruing interest since their last coupon payment. That interest will not be paid out in cash; instead, it will be paid out in the form of six-month zero-coupon EFSF notes. Why? This is just stupid nickel-and-diming: is there any reason why the EFSF is better off paying that money in six months rather than just paying it now?

Second, the bondholders will almost certainly vote, when they tender their old bonds, to bail in everybody who doesn’t tender their bonds, and force them to accept the same deal. That’s the Collective Action Clause (CAC) that you might have been reading about.

Will the CACs be used? Will the exchange even happen? That depends entirely on how many bondholders decide to tender into the exchange. (We’ll assume for the time being that if you tender, you’ll also consent to implementing the CACs; there’s no obvious reason why anybody would do the former without doing the latter.)

In order for the CACs to even come into existence, let alone be triggered, Greece needs two-thirds of its old bonds to be tendered. If it doesn’t reach that threshold, then the whole exchange is a bust and won’t happen at all. Indeed, Greece says in this release that it won’t go ahead with the exchange unless it gets at least 75% participation. If fewer than 75% of Greece’s bondholders tender into the exchange, then Greece won’t accept those tenders, and we’ll have a chaotic default.

If more than 90% of Greece’s bonds are tendered, then the exchange will be a success, the CACs will be triggered, and Greece’s old bonds will be replaced by new bonds. And because the CACs will be triggered, you can be sure that CDS will be triggered as well.

And what happens if the participation rate is between 75% and 90%? That’s vaguer. In that case, says the press release, “the Republic, in consultation with its official sector creditors, may proceed to exchange the tendered bonds without putting any of the proposed amendments into effect”. Which seems to me to say that if you tender into the exchange then you’ll get new bonds, and if you don’t tender into the exchange then, um, well, you’ll be left with your old bonds. The implied threat here is that Greece will pay out on its new bonds but won’t pay out on its old bonds — and bondholders who didn’t participate in the exchange will be left with claims on the Greek government which they’ll be lucky to ever collect on. Of course the CDS would be triggered in that case, too — it would be a clear-cut default. But Greece would have a large outstanding stock of unpaid debt for the foreseeable future.

The idea here is to prevent would-be free-riders from holding out in the exchange, refusing to tender their bonds on the basis that if they hold out, then they’ll just get bailed in by the CACs anyway. That strategy works if there’s more than 90% participation, but it becomes very dangerous if there’s less than 90% participation.

Will this strategy be enough to get 90% of Greece’s bondholders to tender into the exchange? I suspect it might. And of course if the takeup is between 75% and 90% Greece still has the option of exercising the CACs and bailing everybody in anyway. (Note that “may” in the press release which I bolded.) Chances are, that’s what it would do: it’s better for Greece to have one series of bonds outstanding which it isn’t in default on, rather than lots of series of bonds outstanding where it’s in default on most of them. But we won’t know for sure until after the results of the bond exchange are made public. And we won’t even know what bondholders are thinking with respect to the terms of the exchange until we get more details on the GDP warrants and the coupon on the EFSF notes. When will that come? Your guess is as good as mine.


Why don’t the Greek government just replace all the legal BS – with the simple wording along the lines of:-

“Ha Ha – we’re a bunch of fraudsters and we’ve suckered you again – we have your money & you can’t get it back. We might give you some toilet paper in exchange. Now we’re going to gets lots of lovely free money from our fellow swindlers and liars the leaders of the 4th Reich. Of course we won’t pay it back – you the peasants and suckers will do that for us”

Posted by mgb500 | Report as abusive

Matter’s vision for long-form journalism

Felix Salmon
Feb 23, 2012 21:44 UTC

Yesterday morning, a very exciting new journalism project was launched on Kickstarter. It’s called Matter, and it’s going to be home to long-form investigative narrative journalism about science and technology. “No cheap reviews, no snarky opinion pieces, no top ten lists,” they promise. “Just one unmissable story.”

They hit a nerve: as I write this, some 31 hours after the Kickstarter campaign was launched, it has already reached $44,395 of its $50,000 goal, with 569 backers. That’s an average of almost $80 each. “People are giving way more than I thought they would,” said co-founder Jim Giles when I talked to him today. “We have tapped into frustration with the way the internet has promoted quick and cheap journalism and bashed longer-quality stuff, or at least undermined the business model that used to support that sort of thing.”

Matter will surely exceed its $50,000 goal, which is great news, because the more money it raises the better. In the first instance, the $50,000 will be enough to get a nice website up and running, and should also pay for the first three stories on the site. With more money, Matter can get more ambitious: commission more stories, for one thing, but also start building an iPad app which would live in the iOS Newsstand. Or maybe something on Android, or both. There’s a lot of opportunity out there.

This is an old-school Kickstarter campaign, where people are raising the money they need to create something great. It’s not one of those campaigns where donors are essentially pre-buying the product in advance: this isn’t about buying stories before they’re published, or buying subscriptions before the publication even exists. “We’re asking people to make an investment in a sustainable platform for really good journalism,” says Giles, “not to buy a whole bunch of articles in advance.” (That said, anybody pledging $10 or more will get the first three stories, $50 gets you the first six, $100 gets you the first ten, $300 gets you the first 50, and $1,000 gets you a lifetime subscription.)

Once Matter has launched, readers will have the option of buying individual stories for 99 cents each — the Kindle Single model, basically — or buying a subscription. It’ll be monthly at first, and then weekly, assuming everything goes according to plan.

The stories themselves are going to be really good, I think. Matter’s founders, Jim Giles and Bobbie Johnson, are both first-rate journalists, and they’ve quietly amassed a list of really good writers and editors they want to work with. They have a smart model: rather than soliciting detailed pitches, they’re more interested in writers coming to them with vaguer ideas. The writer then gets matched to an editor very early on — before the piece is even formally commissioned — and the final article comes together as a collaboration between the writer, editor, and publishers.

I like this model, because one big weakness of long-form narrative journalism is that it has failed to embrace everything the web is capable of. Writers get commissioned to write X thousand words on Y; they then hand in a document written in Microsoft Word, which goes through a few rounds of editing before getting laid out to a greater or lesser degree. (Ben Hammersley is really good at diagnosing this problem and suggesting how to begin solving it.) I’m optimistic that Matter’s editing process will help its stories be much richer than most of what we’re seeing today.

Matter is coming into a world where companies like The Atavist and Byliner have already broken important ground, and where willingness to pay for content is clearly going up. It’s entirely natural, online, to disaggregate things like magazines, and have a blog over here be really good at what would in a magazine be the front-of-book stuff, while a subscription site over there specializes in features.

And while Matter is quite narrow in what it wants to publish — chiefly long-form, narrative, investigative news stories about science and technology — it’s quite broad in terms of how it intends to distribute that content, and what kind of models it might embrace along the way. For instance, Giles is very keen to work with newspapers, who might help underwrite some of the cost of reporting these stories, in return for being able to break the news in them. Matter would then give those stories the long-form narrative treatment. Or maybe the same story could just appear in both places, if the newspaper covered the costs of the reporting.

In any case, this is a great project, and I’m pretty sure that a lot of the readers of this blog would love to support it. Most long-form journalism these days is political, with much of the rest being in the art-and-literature field. There are thousands of amazing stories in science and technology; I can’t wait for Matter to start uncovering them.


I pay $149 a month for Rackspace cloud sites (cloud server solution) – its elastic and will expand and contract bandwidth according to the traffic volume hitting your site. My point is, I agree with the comment that said $50k is a ridiculous amount of money to build / launch a website.

WordPress = free / or a few hundred for premium theme
Customization: let’s say high end, $500
Cloudsites: $149 per month ($1788 yr)

Now what do I do with the other $47,500?

Posted by TabletCrunch | Report as abusive

How to reduce the deductibility of interest payments

Felix Salmon
Feb 23, 2012 17:44 UTC

I was literally grinning when I read the framework for business tax reform put out yesterday by the White House and Treasury. Admittedly, it’s not going to get implemented any time soon. But it sets the agenda for any attempt to reduce the corporate income tax rate from 35%. And in doing so it makes an official and extremely strong case for massively reducing the tax deductibility of interest payments.

This is not a new idea, of course: Paul Volcker was pushing it in 2009, and the financial commentariat largely loves it: see Jim Surowiecki, for instance, or Steve Waldman, with a wonderful post from January 2008, before we saw a devastating global example of just how damaging too much leverage can be. And if you’re been reading my blog for a while, the idea certainly won’t be new to you.

But now the government has said, very clearly, that it’s on board — something I’ve never seen before. Remember the CBO report which showed that companies financing themselves with equity pay an effective tax rate of 36%, while companies choosing debt pay a negative tax rate of 6.4%? Well, this latest document does that one better:

The effective corporate marginal tax rate on new equity-financed investment in equipment is 37 percent in the United States. At the same time, the effective marginal tax rate on the same investment made with debt financing is minus 60 percent—a gap of 97 percentage points.

This tax preference for debt financing has important macroeconomic consequences. First and foremost, outsized reliance on debt financing can increase the risk of financial distress and thus raise the likelihood of bankruptcy. Unlike equity financing, which can flexibly absorb corporate losses, debt and the associated contractual covenants require ongoing payments of interest and principal and allow creditors to force a firm into bankruptcy. A solvent firm with limited liquidity that is struggling to make its debt payments may experience losses of customers, suppliers, and employees. It may engage in destructive asset “fire sales” and forgo economically profitable investments. And, in an attempt to avoid bankruptcy, levered firms faced with financial distress may resort to high‐risk negative economic value investments. In the broader context, a large bias towards debt financing in the corporate tax code may lead to greater aggregate leverage and the associated firm‐level and macroeconomic costs of debt financing.

As part of the framework, then, the Obama administration explicitly proposes “reducing the bias toward debt financing”, although it doesn’t say by how much. Dan Primack addresses that question today in a smart post; he reckons that 65% of corporate debt interest should be tax deductible, while allowing companies with less than $20 million in revenues to deduct 100% of their debt interest. (And, presumably, banks, too.)

I think this is a very sensible way to have the debate. The tax code can decree the tax-deductibility of corporate debt interest payments anywhere on the spectrum from 0% (which I would love) to 100% (which we have now). There’s no good philosophical reason why it should be 100%, and there are lots of excellent reasons why it should be lower than that. So let’s have a debate about where it should be, and encourage the 1% to come up with their own ideas. As Dan says, a lot of capitalists in areas like venture capital would love the idea of reducing interest deductibility to pay for lower income tax. So let’s see what the Republicans think, and what the business community thinks, and arrive at some kind of consensus. We’re not going to get the deduction abolished completely. But we can definitely make a big move in the right direction.

Update: In the comments, @realist50 brings out the dual-taxation argument, saying that one person’s interest expense is another person’s taxable income. Which isn’t true: if I borrow money from a corporation which isn’t profitable, then no taxes are paid on my interest payments. And in general, interest income is revenue for the lender, not taxable profit. Besides, all dual-taxation arguments are silly. But in this case they’re particularly so. If I’m a company and I make my revenues by selling products to consumers, then my revenues all come from after-tax disposable income. If my revenues come by selling products to companies, then they come from tax-deductible corporate expenses. And if my revenues come by selling products to the government, then they come from tax revenues themselves. None of this helps to determine how much of those revnues should be taxable.

Another reader emails to say that removing the tax-deductibility of debt interest would “penalize investment”. In fact, it would just put various different types of investment — equity and debt — on a more level playing field. And we have a public interest in encouraging equity rather than debt investment: if anything the playing field should tip the other way.


Hey Felix, just wanted to throw out a positive benefit from encouraging debt financing vis-a-vis equity in case you hadn’t considered it…debt financing implicitly encourages productive use of said financing. If my company raises 10m with no future obligations other than a promise to share a future cut of my profits my behavior is likely to be much different than if that 10m came with the strings attached that I have to pay 11.5m in 10 years time; I’m much more likely to put all of that money to productive use to ensure that I can replay that 11.5m in the future.

This isn’t intended to be a defense of the status quo; I don’t think 100% deduction is optimal (of justified) and I am very much in favor of that discussion you speak of. I just wanted to point out that I think wise public policy should indeed encourage debt financing over equity financing to a certain extent for this structural framework to encourage productivity.

Thanks for all of your great work.

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GDP bonds are a really bad idea, part 3

Felix Salmon
Feb 22, 2012 22:37 UTC

Can countries issue equity? Greece is making a stab at it, giving its bondholders GDP warrants which start paying out “in the event the Republic’s nominal GDP exceeds a defined threshold”. Chances are, the market won’t give the warrants much value; they’re more symbolic, really, of Greece’s good faith.

But Bob Shiller is much more ambitious when it comes to such things: “Countries should replace much of their existing national debt with shares of the “earnings” of their economies,” he writes in the Harvard Business Review.:

National shares would function much like corporate shares traded on stock exchanges. They would pay dividends regularly. Ideally, they’d be perpetual, although a country could always buy its shares back on the open market. The price of a share would fluctuate from day to day as new information about a country’s economy came out.

This was a bad idea when Jonathan Ford proposed it in August 2009, it was a bad idea when Shiller wrote about it in December of that year, and it’s an even worse idea now, because Shiller’s decided to kick it up another five notches or so:

Greece’s real GDP fell 7.4% in 2010. If its Trills were leveraged substantially—say, five to one—then the dividend paid on them would have fallen by about 40%. This would have done much to mitigate the crisis, making it easier for Greek taxpayers to bear.

This is almost literally incomprehensible. I spent a long time on the phone today with Shiller’s co-author Mark Kamstra, and even he had no real idea what Shiller was talking about here. I can see how an investor might try to leverage an investment in Greek Trills (a Trill being a bond paying one trillionth of GDP every year, in perpetuity) by buying those bonds with borrowed money. But I can’t see how Greece itself could do so. Shiller doesn’t spell it out, but these things would obviously be symmetrical: Greece would have to pay out five times its annual GDP growth in good years in order to get these large savings in bad years. And that seems like a clear recipe for unsustainable debt growth.

Even Kamstra concedes as much. “I think that a country would not issue a levered Trill,” he told me. “I think it gets you in a lot of trouble.”

But even if you put aside the insane concept of leveraged Trills, the idea behind them is still really bad. Kamstra tried to persuade me that the price of Trills would be less volatile than the S&P 500, and he might be right during periods of relatively normal interest rates. But when rates fall, it seems to me that he’s clearly wrong. A perpetual bond like a Trill is valued by adding up the present value of its income stream: how much is this year’s payment worth to me today, how much is next year’s worth, and so on. When you apply a discount rate, future coupon payments are worth less the more distant they are, and the sum of the total converges to the value of the bond.

If the coupons are steadily increasing, however, the math becomes very dangerous. The coupons will rise at the rate of nominal GDP growth, which in the US will probably be somewhere in the 4% to 5% range over the long term. As a result, if you’re a risk-averse person who wants a perpetual US government security and your discount rate is say 3%, then the expected value of a singe Trill is actually infinite. Of course, no security trades at a price of infinity. But the fact that valuations can get so high in a low-interest-rate environment is all you need to know about just how volatile Trill prices could get.

The point here is that Shiller seems to think that the price of Trills would be driven mainly by “new information about a country’s economy”. But he’s wrong about that. new information about a country’s economy tells you quite a lot about what its GDP might do in the next few years. But if you’re holding a perpetual bond, fluctuations of 1% or 2% in the value of short-term coupon payments are not going to make much difference to the value of the bond. What really makes a big difference is the interest rate you use to calculate net present value. In other words, while Trills are designed to respond to news about the economy, in fact they would be an incredibly noisy and volatile instrument reacting mainly to changes in long-term interest rates.

But what if I’m wrong and Kamstra’s right, and economic news is more important than discount rates? At that point, measuring GDP accurately becomes extremely important: the markets would care greatly about differences of just a percentage point or two.

Except, you really can’t measure GDP to within that degree of accuracy. Here’s a recent paper from the Bureau of Economic Analysis:

Measuring the accuracy of national accounts esti­mates is a long-standing challenge for three main rea­sons. One, the early GDP and GDI estimates are based on partial data and are intended to provide an “early read” on the general picture of economic activity for decision-makers. These early estimates are revised as more complete and accurate source data become avail­able. Two, the source data for the national accounts come from a mix of survey, tax, and other business and administrative data; these source data are subject to a mix of sampling and nonsampling errors and biases that cannot be measured in terms of standard errors. Three, the national accounts are regularly revised to re­flect the changes in the economic concepts and meth­ods necessary for these accounts to provide a picture of the evolving U.S. economy that is relevant and accurate for today’s economy. These updates range from ex­panding the definition of investment from investments in plant and equipment to include investments in computer software to updating seasonal adjustment factors to reflect the most recent seasonal patterns.

What does all this mean in practice? Thomas Dall at the BEA helped me out, taking one recent datapoint as an example: nominal GDP at the end of the first quarter of 2009.

When it was first reported, that number was $14.097 trillion. But then three months later, in July 2009, it was revised upwards, to $14.178 trillion. A year after that it was revised back down, to $14.05 trillion, and a year after that, in July 2011, it came down further, to $13.894 trillion. In other words, between July 2009 and July 2011, the GDP figure for the first quarter of 2009 was revised down by $284.3 billion, or 2% of GDP.

And Dall didn’t pick that datapoint because it was particularly noisy: it’s the only one we looked at.

This is bad news for any government thinking of issuing Trills. Governments, after all, go to great lengths to issue easily-understandable series of bonds with fixed coupons, so that the financial markets can price them easily and have a transparent yield curve. The only people welcoming GDP bonds with open arms would be in futures markets, where traders love volatility and try to make lots of money off it.

Which, of course, is the whole reason that Shiller is pushing this idea so aggressively. Shiller is a principal in a company called MacroMarkets, which exists to create “innovative financial instruments to facilitate investment and risk management” — a/k/a volatile new derivatives.

If Trills existed, you can be quite sure that MacroMarkets would immediately create futures and options based on Trills, trying to make money off their volatility. The volatility would depress the price that governments could sell the Trills for, but at the same time it could make a fortune for Bob Shiller. “Bob’s experience in the markets is that if there isn’t enough volatility in the price of the contract, the speculators lose interest in the contracts,” says Kamstra.

So let’s discount Shiller, here, as someone who’s way too conflicted to take at face value about such things. GDP bonds are like most financial innovations: they’re much more likely to do harm than they are to do good. And no country should even dream about issuing such things until some big corporation has blazed the trail first, as a kind of proof of concept. Lots of companies, from Walmart to ExxonMobil, do better in good economies and worse in bad economies: it might make sense for them to issue GDP bonds. Let’s wait until one of them does, so that we can get a feel for how such bonds behave, before we ask our governments to follow suit.

I feel we’ll be waiting a long time. If it’s true that the price of a GDP bond can skyrocket when interest rates fall, that bond would be extremely dangerous for any company issuing it. The market value of the company’s outstanding bonds could easily exceed the company’s enterprise value, with the result that technically shares in the company would be worthless. I can’t imagine any CFO or corporate treasurer risking it. And neither should any finance minister.


““As a result, if you’re a risk-averse person who wants a perpetual US government security and your discount rate is say 3%, then the expected value of a singe Trill is actually infinite.”
This statement doesn’t make sense – discount rates should differ based on the riskiness of the cash flow they are discounting, and 3% is way too low for an equity-like instrument like a GDP bond. ”

It’s worse than that. It’s the same as valuing ecological assets — there is uncertainty in the appropriate “interest” rate, in the one case the relevant discount rate, in the other case the relevant growth rate. This uncertainty is extremely important because of the projection to infinity. If your range of possible valid values for this rate includes 0, then you get strange things happening that depend on exactly how you take your limits.

The bottom line is that, in a context of the real uncertainties of the situation, projecting all the way to t=infinity makes no sense — all that makes sense is to project as far as you are confident in projecting and then make a reasonable assumption about what happens after that. There are various reasonable assumptions one might make, but plenty of them do not value such a financial instrument as having a price of infinity.

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The epistemics of Greek default

Felix Salmon
Feb 22, 2012 15:40 UTC

Are you alarmed by today’s headline in the NYT saying, disturbingly, that the “Greek Crisis Raises New Fears Over Credit-Default Swaps”? Don’t be. The article in question turns out to be a solid 770-word explainer by Peter Eavis in which he gives the final word to Stanford’s Darrell Duffie, saying that any such fears are “small potatoes”.

But at the beginning, Eavis talks about how European policymakers “fear that payments on the swaps might set off destabilizing chain reactions through Europe’s financial system”; later on, he writes that “the swaps will also come under heavy fire if there is any indication that activating the Greek instruments is leading to stress in the financial system”. It would have been nice if he’d named one of those policymakers, or explained what exactly their fears might be.

How, exactly, would a CDS trigger lead to stress in the financial system? After all, as Eavis concedes, every time banks’ balance sheets have been examined, regulators have found essentially nothing in the way of unhedged CDS exposures.

There is the possibility of counterparty risk — a spectre Eavis raises only to dismiss it. In order for counterparty risk to be a problem, you need two things. First, you need a bank with a very large unhedged CDS exposure to one single name — the kind of position I’ve never seen any bank have. (Remember here that credit default swaps were invented for banks to sell down their loan exposure, not to increase it.) And then, on top of that, you need jump risk: the risk that the single name in question will suddenly default, forcing the bank to pay out a huge amount of money at once.

But in Greece, there is no jump risk at all. Because a default has been priced in for months, any bank which has written default protection on Greece has had to steadily post more and more margin against that position. When Greece officially defaults at the end of March, there will be an auction to determine the clearing price of the swaps, and the margin will simply get transferred to the bank’s counterparty. The bank will probably need to make no payment at all.

In other words, counterparty risk on sovereign CDS is probably a non-issue, but it’s certainly a non-issue in Greece.

So what are the “new fears” of Eavis’s headline? I’m beginning to think that in fact the fears are not that the swaps will get triggered, causing some kind of financial calamity, but rather that they won’t be:

Some chance remains that the exchange could be done voluntarily, avoiding a default swap event. That outcome would most likely prompt a torrent of criticism that the swaps did not cover holders against losses, as they were intended to.

“The whole nature of the C.D.S. contract would be called into question,” said Richard Portes, professor of economics at the London Business School.

As Eavis says, the chance of the swaps not being triggered is extremely small, at this point. But it’s higher than the chance that the trigger will cause some kind of financial-market calamity. It’s possible — unlikely, but possible — that Greece will get such a large acceptance rate on its exchange offer that the size of the holdouts would be very small indeed. If that happens, it’s also possible-but-unlikely that Greece will choose to simply continue paying those holdouts in full, rather than defaulting on them or trying to bail them into the deal through CACs. If both of those possible-but-unlikely things happen, then it’s definitely possible ISDA would determine that there was no credit event. But we’re so far down the chain of speculation at this point that these things are really not worth worrying about; the unanimous consensus in the market is that there will be a default, in March, and that the CDS will get triggered.

The thing that really worries me is not the CDS market at all. In fact, for all that credit default swaps were an intrinsic part of the financial crisis, the traded market in CDS has been remarkably robust. It certainly withstood the bankruptcy of Lehman without any trouble, both in terms of counterparty risk relating to Lehman’s own positions and in terms of CDS on Lehman being triggered when the bank failed.

Rather, what worries me is that the vast majority of people reading this article in the NYT will see the headline about New Fears, and if they skim the article will just see a bunch of concerns and some quotes from people on both sides. In other words, Eavis’s article is to a large degree self-fulfilling: people will read it and start being worried about the CDS market all over again, especially if — like 99% of the population — they don’t really understand the CDS market at all, and have no particular need or desire to get into the nitty-gritty. All they know, or think they know, is that credit default swaps are Dangerous Complex Derivatives, and that the Greek crisis is making them more dangerous still.

Meanwhile, Eavis never touches on what I’m pretty sure is the real reason that European policymakers are worried about a CDS trigger. A lot of people have been asking me about the Greek deal in recent days and weeks, and I get a lot of questions like the one I was asked yesterday by Amanda Lang, who asked whether default was in fact inevitable and whether Greece was just putting it off with this deal, kicking the can down the road. A lot of otherwise very well-informed people still think that this bailout is like previous bailouts, designed to avert a default. When in fact a huge default is right at its very heart. When the CDS get triggered, it’s going to be very obvious that this is indeed a Greek default. That’s something which bond market professionals are acutely aware of, but it hasn’t really sunk in to the broader popular consciousness.

If the Greeks and the Europeans can structure a deal where the credit default swaps aren’t triggered and the bondholders voluntarily swap their old bonds for new bonds, then it’s actually possible that this misunderstanding could continue well past the bond exchange, to the point that the broad public thinks that we’ve just seen another bailout, and misses the footnote that the bailout was accompanied by the single largest bond default in the history of the world.

If all goes according to plan, this is going to be an orderly bond default, to be sure — in contrast to the very disorderly defaults we’ve seen in recent years in countries like Argentina and Ecuador. But make no mistake: Ecuador Greece owes €14 billion to its bondholders on March 20. It is not going to make that payment, and instead bondholders who are currently owed 100 cents on March 20 will find themselves instead with a mixture of securities worth maybe 26 cents on the open market. When the CDS get triggered, that fact is going to get hammered home. Because although it has long been priced in to the market, it still isn’t broadly understood.


dWj, they will of course sue the bank that they bet with for failing to disclose something irrelevent….

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Europe’s inevitable Greek divorce

Felix Salmon
Feb 22, 2012 07:04 UTC

I had a little bit of fun amidst all the seriousness on Canadian TV yesterday, laying out my genius solution to the Greek crisis: Canadians. (My segment starts at about 19:20 in.) Essentially, Germany wants Greeks to become German: to stoically accept real wage deflation while working hard and paying their taxes in a good Protestant manner. Canadians are well-educated, productive, and very good at paying their taxes; what’s more, they’d probably like somewhere warmer to live, especially in the winter. So bring all the Canadians to Greece, where they could help turn the economy around, and leave Canada to the commodity companies and the Chinese property speculators. It’s basically the Davos to Greece idea, taken to its logical conclusion.

Underneath it all is the simple truth that economic growth is caused by people. Ever since the Eurozone was created, Europe has been quite clear about the fact that economic and monetary union can’t work without labor mobility. But sadly, the ability of Europeans to work in any EU country has meant an outflow of skilled professionals from Greece, when what it really needs is an inflow.

If you really want structural reform in Greece, a lot of that is going to have to come from new blood — northern European entrepreneurs and corporations setting up shop in Greece to take advantage of the large supply and low cost of labor there, as well as all the advantages of being both in the EU and in the Mediterranean. But that’s not going to happen so long as you read stories like this one, about how it took ten months to get permission to launch a website selling olive-oil-based products to the US market.

Antonopoulos and his partners spent hours collecting papers from tax offices, the Athens Chamber of Commerce and Industry, the municipal service where the company is based, the health inspector’s office, the fire department and banks. At the health department, they were told that all the shareholders of the company would have to provide chest X-rays, and, in the most surreal demand of all, stool samples.

Once they climbed the crazy mountain of Greek bureaucracy and reached the summit, they faced the quagmire of the bank, where the issue of how to confirm the credit card details of customers ended in the bank demanding that the entire website be in Greek only.

When politicians talk about “structural reform” in Greece, they mean cutting out a lot of this kind of red tape. But that takes time, which Greece doesn’t have. Besides, you need some kind of financial system to support new businesses, and Greece’s banks are barely lending at this point.

The really big picture here is that European monetary union is a marriage — and not a happy one, right now. In any marriage, if one partner falls on hard times, it’s incumbent upon the other to support them. If they can’t, or won’t, then divorce is surely in the cards. Similarly, if one partner doesn’t trust the other, then the marriage will not last long. The latest Greek bailout is being sold with the idea that Europe will support Greece indefinitely, and trusts Greece to do everything it’s promised. Neither passes the laugh test. And so, rather than moving to Greece to help rebuild its economy, the rest of Europe will ultimately split up with its noncontiguous partner. The only question is when.


“wait a sec, TFF, you’re not suggesting Whitman is an entrepreneur?”

Sorry, KenG, I realized after I posted that I was conflating two ideas. :) No, not an entrepreneur. But she sprung to mind as an East Coast transplant!

And yes, Boston is at the same latitude as Rome. Same daylight hours, just a little more snow. :)

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Adventures with primary documents, sustainability-analysis edition

Felix Salmon
Feb 21, 2012 18:40 UTC


This chart, from the European Commission’s debt sustainability analysis of Greece, has been doing the rounds today. I posted it last night, and it got picked up by Joe Weisenthal as his chart of the day; it’s a very striking visualization of the degree to which the Greece bailout plan lies somewhere between optimistic and delusional.

I’m happy to say that Reuters was the first organization to get its hands on this analysis. At 4:21 EST, we ran our exclusive story, by Jan Strupczewski in Brussels, with the headline that Greek debt would still be 160% of GDP in the European Commission’s downside scenario. Jan took the 2,800-word analysis, and its wealth of charts and tables, and boiled it down into a 965-word story which was avidly read by news consumers around the world.

Later on, the FT’s Peter Spiegel also got his hands on the Commission’s analysis. His story ran at 6:15 EST, and was even shorter, at 566 words.

Necessarily, both stories cut out material from the original report, and as it happens neither of them mentioned the sharp uptick in future GDP growth. The first place I saw that was at Alphaville, with an anonymous post timestamped 02:44 GMT (someone was up late), which was 9:44 EST. “The baseline scenario in the report forecasts 4.3 per cent decrease in GDP this year,” said Alphaville, “followed by flat growth in 2013 and 2.3 per cent growth in 2014.” Clearly they had the analysis themselves, since those figures weren’t being reported anywhere else at the time.

But it wasn’t until 10:47 EST that the report finally appeared online, at Zero Hedge, allowing me to write my post. The Zero Hedge post has now reached 20,000 pageviews — a very big story by ZH standards.

Once the analysis was freely available online, it started propagating elsewhere, too: Alphaville (which, remember, had had access to it six hours earlier) finally posted it at 08:49 GMT, or 3:49am EST.

The analysis is very well written, clearly by a native English speaker:

There is a fundamental tension between the program objectives of reducing debt and improving competitiveness, in that the internal devaluation needed to restore Greece competitiveness will inevitably lead to a higher debt to GDP ratio in the near term. In this context, a scenario of particular concern involves internal devaluation through deeper recession (due to continued delays with structural reforms and with fiscal policy and privatization implementation). This would result in a much higher debt trajectory, leaving debt as high as 160 percent of GDP in 2020. Given the risks, the Greek program may thus remain accident-prone, with questions about sustainability hanging over it.

As such, I think it’s fair to say that the analysis itself was intrinsically superior to any of the news reports written about it. Given the choice between reading the Reuters story, or the FT story, or the primary document, virtually all market participants would plump for the primary document.

And yet neither Reuters nor the FT posted the document when they got their hands on it, preferring instead to simply write it up in their own words. Zero Hedge got the document more than six hours after Reuters did, but still gets all the glory of being the first site to post it.

There are three lessons here. The first is that reporters still don’t like posting primary documents, for various possible reasons. They might be worried about being sued for copyright violation, or they might have promised their source they wouldn’t post the document. More generally, reporters tend not to want to give away to their competitors information which they worked very hard to obtain. And as such, they’re often perfectly happy to promise not to post such documents: because they didn’t really want to in the first place.

The second is that legacy news organizations like Reuters and the FT still don’t think digitally: the unit of news is always the story, rather than, say, a primary document in PDF form. So if you obtain a primary document, the first thing you do is turn it into a story, rather than simply letting that document be the story.

Finally, it’s silly to assume that reporters are going to be particularly expert at extracting all the germane information from a report when they write it up. Especially when you’ve had a very long day, it’s late at night, you’re under time pressure, and you are looking at the document from a particular, inside-baseball perspective. Sometimes, reporters can add value when they write up primary documents, by putting them in perspective and in plain English. Other times, they miss important things. Either way, posting the document itself along with the write-up can only make the news story richer and more valuable. Even if doing so also helps the competition.


News. What is it? When I read a newspaper or a blog, I ask myself “how many verifiable, actual FACTS are in this article?” Are the facts important? What are the important facts?

Now I just don’t look at FRED (St Louis Federal Reserve graphs) because I often need some interpretation and insight into what it means. Also, with all the facts in the world, I need somebody to filter out this avalanche of information and distill it down.

At some point, the news industry will figure out to always provide the raw data. There will be plenty of demand for distillation – just maybe not as much as there is now.

It used to be that you needed reporters to give you the synopsis of some Federal report or politicians speech. Now you can see it for yourself.
Remember Trent Lott – and his comment at Strom Thurman’s birthday party? An incident not particulary emphasized by the news media intially – but when the general public (or some members of it) saw it, what the media and the public thought noteworthy turned out to be considerably different.

We’re seeing it time and time again – politicians ability to taylor messages to certain groups is decreasing because of mobile phones and the ease of recording, as well as the ability for anyone to read the entire text of a speech on the internet. As well as the fact that the internet doesn’t forget…

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The improbable Greece plan

Felix Salmon
Feb 21, 2012 06:16 UTC

Greece is now officially a ward of the international community. It has no real independence when it comes to fiscal policy any more, and if everything goes according to plan, it’s not going to have any independence for many, many years to come. Here, for instance, is a little of the official Eurogroup statement:

We therefore invite the Commission to significantly strengthen its Task Force for Greece, in particular through an enhanced and permanent presence on the ground in Greece… The Eurogroup also welcomes the stronger on site-monitoring capacity by the Commission to work in close and continuous cooperation with the Greek government in order to assist the Troika in assessing the conformity of measures that will be taken by the Greek government, thereby ensuring the timely and full implementation of the programme. The Eurogroup also welcomes Greece’s intention to put in place a mechanism that allows better tracing and monitoring of the official borrowing and internally-generated funds destined to service Greece’s debt by, under monitoring of the troika, paying an amount corresponding to the coming quarter’s debt service directly to a segregated account of Greece’s paying agent.

The problem, of course, is that all the observers and “segregated accounts” in the world can’t turn Greece’s economy around when it’s burdened with an overvalued currency and has no ability to implement any kind of stimulus. Quite the opposite: in order to get this deal done, Greece had to find yet another €325 million in “structural expenditure reductions”, and promise a huge amount of front-loaded austerity to boot.

The effect of all this fiscal tightening? Magic growth! A huge amount of heavy lifting, in terms of making the numbers work, is done by the debt sustainability analysis, and specifically the assumptions it makes. Greece is five years into a gruesome recession with the worst effects of austerity yet to hit. But somehow the Eurozone expects that Greece will bounce back to zero real GDP growth in 2013, and positive real GDP growth from 2014 onwards. Here’s the chart:


Note that the downside, here, still looks astonishingly optimistic: where’s all this economic growth meant to be coming from, in a country suffering from massive wage deflation? And under this pretty upbeat downside scenario, Greece gets nowhere near the required 120% debt-to-GDP level by 2020: instead, it only gets to 159%. And to make things worse for the Eurozone, the report explicitly says that under the terms of this deal, “any new debt will be junior to all existing debt” — in other words, there’s no way at all that Greece is going to be able to borrow on the private markets for the foreseeable future, so long as this plan is in place.

As in all bankruptcies, the person providing new money gets to call the shots. And it’s pretty clear that the Troika is going to have to continue providing new money long through 2020 and beyond. Under the optimistic scenario, Greece’s financing need doesn’t drop below 7% of GDP through 2020. Under the more pessimistic scenario, it’s 8.8%. And here’s the kicker: all of that money is being lent to Greece at very low interest rates of just 210bp over the risk-free rate. Much higher, and Greece’s debt dynamics get even worse. But of course even with well-below-market interest rates, Greece is still never going to pay that money back.

The cost of this plan is €130 billion right now, and €170 billion over three years, through the end of 2014; it just continues going up from there, with no end in sight. Remember that total Greek GDP, right now, is only about €220 billion and falling.

Oh, and in case you forgot, this whole plan is also contingent on a bunch of things which are outside the Troika’s control, including a successful bond exchange. The terms of the deal, for Greek bondholders, are tough: there’s a nominal haircut of 53.5%, which means that you get 46.5 cents of new debt for every dollar of existing bonds that you hold. The new debt will be a mixture of EFSF obligations and new Greek bonds; the new Greek debt will pay just 3% interest through 2020, and 3.75% until maturity in 2042.

The plan assumes that 95% of bondholders will accept this deal, which seems optimistic to me. Bondholders are by their nature a fractious and contrarian bunch, and Greece is not saying that it’s going to default on holdouts. As a result, bondholders have to guess what might happen if they fail to tender into the exchange: they might get defaulted on and receive nothing; they might get paid out in full; or they might get defaulted on while being offered, for the second time, the same exchange they’re being offered right now. Some of them, especially the ones holding English-law bonds, might well be tempted to hold on to at least some of their bonds, just to see what happens.

More to the point, the plan assumes that Greece’s politicians will stick to what they’ve agreed, and start selling off huge chunks of their country’s patrimony while at the same time imposing enormous budget cuts. Needless to say, there is no indication that Greece’s politicians are willing or able to do this, nor that Greece’s population will put up with such a thing. It could easily all fall apart within months; the chances of it gliding to success and a 120% debt-to-GDP ratio in 2020 have got to be de minimis.

Europe’s politicians know this, of course. But at the very least they’re buying time: this deal might well delay catastrophic capital flight from Greece, and give the Europeans more time to work out how to shore up Portugal if and when that happens. Will they make good use of the time that they’re buying? I hope so. Because once the Greek domino falls, it’s going to take a huge amount of money, statesmanship, and luck to prevent further dominoes from toppling.


1. No one forced Greece into the Euro. Greece forced itself in.
2. No one forced Greece to keep up an arms race with Turkey. That is, and was Greece’s decision.
3. No one forced Greece to overborrow. That was Greece’s decision.
4. No one forces Greece to stay in the Euro. Greece can default completely and exit the Euro.
5. But Greece cannot expect the rest of the EU to keep paying for its bad decisions.

Posted by Staufer | Report as abusive

Aleynikov goes free

Felix Salmon
Feb 17, 2012 22:27 UTC

Count me in, with Choire Sicha, as being very happy that Sergey Aleynikov is once again a free man. To cut a long story short, Aleynikov used to work in high-frequency trading for Goldman Sachs, earning $400,000 a year. He then got offered a job in Chicago, earning three times that amount. So he accepted the new job. On his last day at Goldman, he uploaded to an external server various bits of code that he had worked with at Goldman. He claimed that the code was benign open-source material; Goldman claimed that it could be used to “manipulate markets”.

Goldman’s claim backfired in one respect, in that it sparked a thousand semi-informed articles about high-frequency trading and how dangerous it is: articles which did Goldman’s reputation no good at all.

On the other hand, the claim did have its chief intended effect — it got U.S. authorities extremely excited, to the point at which they charged Aleynikov with criminal activity under the Economic Espionage Act.

Now the EEA was designed — and was initially used — to prosecute very different behavior, chiefly employees at defense contractors taking top-secret information and giving it straight to the Chinese government. The kind of thing which can absolutely be considered espionage.

The secrets at defense contractors, of course, are secret for reasons of national security. The secrets at investment banks and hedge funds, by contrast, are secret purely for reasons of profit: they reckon that if they have some clever algorithm which nobody else has, then that makes it easier for them to profit from it. Which is why it was always a stretch for the government to use the EEA to prosecute Aleynikov — indeed, it is why it was always a stretch for Aleynikov to be criminally prosecuted at all. Goldman could have brought a civil case against him, but instead they got their wholly-owned subsidiary, the U.S. government, to come down on him so hard that he ended up with an eight-year sentence. Violent felons frequently get less.

The forthcoming decision from the Second Circuit is likely to be a doozy; I’m told that the judges shredded the prosecutors during the oral hearing. And certainly their decision to enter a judgment of acquittal, rather than any kind of retrial, is a strong indication that they handed down this order with extreme prejudice against prosecutorial overreach.

Is it the government’s job to expend enormous prosecutorial resources protecting Goldman Sachs from competition? The Second Circuit certainly doesn’t seem to think so, and neither do I. Aleynikov’s actions were certainly stupid, and quite possibly illegal. But the way that Goldman managed to sic New York prosecutors on him bearing the sledgehammer of the EEA was far from edifying. And I’m glad that both Goldman and the Manhattan U.S. Attorney are surely feeling very chastened right now.


The court actually issued its opinion in this matter on April 11:

Jacobs said that the language of the statute refers to products that have been “produced for or placed in interstate or foreign commerce….”. This, then, includes two sorts of product, both with a limited meaning, those that have “already been introduced into [placed in] the stream of commerce” on the one hand and on the other hand to those that “are still being developed or readied” [produced for] such placement. The words evoke two distinct sets of products with a sequential relationship to one another, which satisfies well-established rules of statutory construction.

Aleynikov’s work was specifically in the development of “infrastructure programs that facilitate the flow of information throughout the trading system and monitor the system’s performance.” That trading system was created for the sake of engaging in commerce without regard to state or national lines. But the infrastructure of that system does not thereby satisfy the language “produced for or placed in….”

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