How lucky are Greece’s bondholders?

By Felix Salmon
March 8, 2012
Nouriel Roubini -- which I think is putting it a bit strongly.

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“Greece’s private creditors are the lucky ones,” says Nouriel Roubini — which I think is putting it a bit strongly. Nouriel — who at one point was one of the world’s foremost econobloggers — is falling back on bad habits here: he says that “a myth is developing” about the official sector getting off scot free in Greece, and goes on to tell us how “the argument runs”. But he doesn’t link to any such argument — and I’d dearly love to know who he has in mind, and what exactly they’re saying.

Nouriel then gives a good overview of the degree to which the official sector really is bailing out Greece. This is important to remember: just because bondholders are taking a haircut, doesn’t mean this isn’t a bailout. It is. Greece is running a massive budget deficit, even before interest payments on its debt. It can’t borrow the money to cover that deficit in the markets, either foreign or domestic. Which means that the only thing standing between Greece and bankruptcy is the Troika, throwing billions of dollars at the Greek government to avert insolvency. As Nouriel says, this should give the Troika seniority, on the grounds that they’re providing the equivalent of “debtor-in-possession” financing.

Nouriel’s attempts to paint the private sector’s 75% haircut as a good deal which is “too little”, however, are less convincing. He’s right that once Greece’s new bonds are issued under English law, the Greek government can’t unilaterally convert them to drachmas — or to worthless scrip, for that matter. But as Nouriel well knows, that’s a fact of life for countries of dubious creditworthiness: the markets are always suspicious when they try to issue under their own laws. If Greece wants to give anything of real value to its bondholders, then it has to offer bonds issued under English law, because no one will believe its promises to pay, otherwise.

Put it this way: someone in the Greek government genuinely intends that the country is actually going to make all of its payments on the new bonds. Insofar as the Greek government is believed with regard to that promise, the new bonds are going to have real market value. But in order for bondholders to be able to realize that value, the bonds have to be issued under English law. If Greece came out with exactly the same offer but kept the new bonds under Greek law, then the haircut would be substantially larger than 75%, because the new bonds would trade at a significantly lower price when issued. So the governing-law aspect to all this is already incorporated in the haircut, and by choosing English law, Greece is simply maximizing the value of its bonds without increasing its total indebtedness by a penny.

And this argument of Nouriel’s makes very little sense to me:

Greece’s private creditors should stop complaining and accept the deal offered to them. They will take some losses, but they are limited and, on a mark-to-market basis, the debt exchange offers them a potential capital gain. Indeed, the fact that the new bonds are expected to be worth more than the old suggests that this PSI exercise has further transferred losses to Greece’s official creditors.

The job of the market — which it normally does quite well — is to anticipate how big a Greek haircut is going to be, and then arbitrage Greece’s bonds appropriately, pricing them at a level such that bondholders tendering into the exchange wouldn’t be better off simply selling their bonds instead. (If they would be better off selling their bonds instead, then the buyer of those bonds is pretty stupid, and is going to end up making a loss.) So by definition, an exchange offer always offers “a potential capital gain” to bondholders, just because the market price before the exchange has to be a little bit lower than the expected value of the new securities after the exchange.

What’s more, Greece has to offer something, or else there won’t be an exchange at all, and instead there would just be a chaotic default which would be extremely damaging to all concerned. Already, the majority of the value in the package being offered bondholders is not coming from the new Greek bonds, but rather from European EFSF securities. The value of the new Greek bonds is only about 10 cents on the dollar — a 90% NPV haircut. It doesn’t get much bigger than that.

There are very good reasons why Greece would love to remain a member in good standing of the international community — not least that it wants to remain a member in good standing of the European Union, with Greek banks retaining most if not all of their current deposit base. As such, it has to take its bonded obligations reasonably seriously. The last thing it wants is protracted litigation with bondholders a la Argentina, where bondholders have recently been winning small but important victories in the US courts. Argentina is going to have to spend the foreseeable future being extremely careful with its sovereign holdings, for fear that they will otherwise be attached by its creditors. Greece doesn’t want to be an international pariah like that.

So while I’m shedding no tears for Greece’s bondholders, who took a risk which didn’t pan out, neither am I going to go as far as Nouriel and say that they’re getting a good deal. They’re not. They’re getting 25 cents on the dollar. Just imagine what would happen if Greece tried to make that kind of offer to other holders of sovereign obligations, like its pensioners.

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