Felix Salmon

The euro crisis comes to a head

Felix Salmon
Sep 12, 2011 13:29 UTC

Spiegel has an excellent, long, and detailed article about the tension at the heart of the euro crisis — the one between Greece and Germany. Europe has thrown $150 billion at Greece to date and has nothing to show for it except for a temporarily averted sovereign default. If that kind of money continues to rain down on Greece, the outcome will be similar — immediate crisis averted, but no real change in terms of the Greek sovereign finances. Austerity, it turns out, is working exactly the way it always does: it’s slowing down the country and making any recovery pretty much impossible.

Up until now, the EU’s attitude to Greece was a bit like Tim Geithner’s attitude to the debt ceiling: Greece will implement the reforms it has promised, it will recover economically, we will give them the liquidity they need from the EFSF, there is no alternative. But now, starkly, two alternatives have emerged blinking into the harsh light of the market. Either Greece defaults and remains in the euro; or it defaults and leaves the euro. This is not an orderly London Club bail-in default with a modest 21% haircut and an exit yield of 9%: rather, it’s a proper we-can’t-pay-our-debts default with significant losses for all banks holding Greek debt — including the ECB.

Meanwhile, with the exit of Jürgen Stark, the ECB itself has clearly reached the limit with respect to how much it can help the eurozone stay intact. Stark’s replacement — almost certainly another German Bundesbank type — may or may not be as hardline as Stark was. But Friday’s news underlines that the ECB is emphatically not going to behave during this crisis as the Fed did during the last one — by subordinating itself to broader necessities, and making its first priority that it do everything in its power to ensure that a coherent and coordinated crisis-response plan is adhered to. To put it another way: Bernanke, ultimately, did what Paulson wanted him to do. It’s not at all clear that Mario Draghi will be able to behave the same way.

So the latest swoon in European and global markets makes sense: we’re at an inflection point, in Europe, and all the signs are pointing to more chaos and uncertainty. The last crisis brought Europe and the world together, at least briefly. This one is tearing Europe apart. The unity that we saw at the G20 summit in London in 2009 is nowhere to be seen, and there’s no indication that it’s going to emerge again, at least not before it’s too late. Most of the time, market reports of “worries over Europe” are code for “global stock markets fell, and we don’t know why.” This time, I think they’re legit.


great comments by an intelligent group of posters. thanks!

Posted by boldthinker | Report as abusive

Europe’s lethal uncertainty

Felix Salmon
Sep 6, 2011 15:54 UTC

As markets plunge again today, ostensibly on existential worries about the eurozone, you might want a plain-English explanation of what the root of the problem is. And John Lanchester is a great place to turn for such things:

On 16 August, Nicolas Sarkozy and Angela Merkel had an emergency meeting to decide what to do about the Eurozone crisis. After it, they gave a press conference at which they spoke in platitudes about the need for Europe to improve its ‘economic governance’, avoiding all specifics. They precisely and explicitly ruled out the only two things which would have helped: the creation of ‘eurobonds’, i.e. debts backed by the full economic weight of all the countries inside the eurozone; and the extension of the €440 billion European Financial Stability Facility. It’s easy to see why they did this, and their reasons are entirely to do with the domestic unpopularity of giving more aid to the indebted and severely struggling ‘Club Med’ countries of Southern Europe. Unfortunately, Merkel and Sarkozy’s inaction is a recipe for certain disaster. Everybody and his cat knows that the eurobond is the only way out of the crisis for the eurozone in the medium term; as for the necessary size of the short-term bailout facility, Gordon Brown’s guesstimate was €2 trillion. That ‘could have convinced the markets that Europe meant business’. Huge, sustained and manifestly undeflectable government intervention on that scale is the only thing which will cause the speculators and hedge-funders and ‘hot money’ types to back off. Instead, nothing.

Lanchester’s full essay is well worth reading, and helps to put today’s news in perspective. When Mario Draghi says that Europe needs to “make a quantum step up in economic and political integration,” he’s basically agreeing with Christine Lagarde that Europe’s nations need to stand together. And when elected leaders signally fail to say the same thing, markets fall.

Meanwhile, amazingly, the Greek bond exchange is still far from a done deal, and Landon Thomas does his best to try to explain how Europe’s banks are being pushed to accept it:

This week, bankers representing the Greek government — Deutsche Bank, BNP Paribas and HSBC — have been explaining to investors why it is in their interest to trade in their decimated Greek bonds, take a 21 percent loss and accept a new package of longer-dated securities with AAA backing…

With the price of Greek debt trading in some cases at 50 cents on the dollar — even lower than when the bailout deal was announced in July — the 21 percent haircut seems to be quite a bargain.

As a bonus, the new bonds would be governed by international law, rather than Greek law. That is a significant alteration of lending terms that would strengthen the negotiating hand of the bondholders if Greece eventually concluded it had no alternative but to default — even after this latest bailout.

The math isn’t quite as simply as Thomas implies — if you take a 21% haircut on a bond, the new instrument is not automagically going to be worth 79 cents, even if it does have “AAA backing”. That backing will be in the form of long-dated zero-coupon collateral which is hard for bondholders to extract, and the new debt will still have a low credit rating and a large amount of default risk baked in.

But the governing-law part of the deal is important. Thomas cites (but doesn’t link to) Lee Buchheit’s important paper on that topic. Basically, current Greek debt is in many ways worthless to bondholders: if and when Greece defaults, they have no legal recourse. But if the exchange goes through, then the new Greek debt will give bondholders real teeth in the event of default.

There’s still a lot of weirdness going on in Greece’s debt, especially at the short end of the yield curve. Consider this, for instance: the Greek bond maturing on January 11 is trading at par — the market expects it to be paid in full, and the yield on the bond is in single digits. But the Greek bond maturing on March 20 is trading at about 63 cents on the dollar, for a yield well into triple digits. Meanwhile, the bond maturing on May 15 is trading in the low 80s, for a yield of around 30%.

There might be a good explanation for why short-dated Greek debt is trading so oddly, or it might just be an artifact of illiquidity. But the general chaos and uncertainty that’s reining in Europe right now is very reminiscent of the height of the financial crisis. Crises of confidence are always self-fulfilling, and the longer governments take to react to them, the worse they get. Europe, by its nature, moves slowly. And that’s bad news for global markets.



I don’t see how these two sentences fit togeather:

“even if it does have “AAA backing”. That backing will be in the form of long-dated zero-coupon collateral which is hard for bondholders to extract, and the new debt will still have a low credit rating and a large amount of default risk ”

How can the new bonds have both AAA collateral backing and default risk? How is this not different from having FDIC insured deposits in the 100 weakest banks in the country. Sure there are some forms to fill out and you might not get your check until next Thursday but you know you’ll get your principal and interest.

If you can buy some Greek bonds at 50c swap them for 79c worth of new Euro backed bonds you’ve made what looks like a pretty safe profit. It will be interesting to see if Bill Gross is doing this in size.

Posted by y2kurtus | Report as abusive

Greece datapoints of the day

Felix Salmon
Aug 30, 2011 21:04 UTC

Nikos Tsafos has a fantastic post at his Greek Default Watch blog entitled “Ten Surprising Facts about the Greek Economy”. I normally hate listicles, but this one’s very good. For instance: it’s bad enough that Greek GDP won’t go back to its 2008 peak for the best part of a decade. But it’s worse that the two big drivers of Greece’s economy — tourism and shipping — are down 28% and 27% respectively in real terms since 2000.

Other parts of the list are equally surprising. Did you know that Greece’s 2011 budget deficit is just 40% of the size of its official tax arrears? Or that Greece has only really gone on a massive borrowing binge twice? Once between 1980 and 1993, and then again between 2007 and today. I, for one, didn’t know that Greece has the lowest level of private-sector debt in the eurozone — only about 150% of GDP, compared to well over twice that in Portugal.

One endgame for Greece is a managed departure from both the euro and the EU, with the ECB coming up with a mechanism for protecting depositors in Greek banks — George Soros, for one, says that “the Greek problem has been sufficiently mishandled by the European authorities that this may well be the best solution”. But that day is still a long way off. There’s no appetite in the EU generally for such a move, and even less in Greece. After all, the costs associated with ejection would be enormous — on the EU side for the bank deposit guarantees, and on the Greek side from the loss of all the benefits that come with EU membership. Meanwhile, the benefits on both sides are more amorphous and unpredictable. Argentina suddenly started growing after it devalued; Greece might not.

For the time being, then, the best we — and Greece — can hope for is more plans along the lines of “maybe if we tie two rocks together, they’ll float”. That, and continued austerity and stagnation. Joining the euro was, in hindsight, a really bad idea for Greece. But it’s one which is very unlikely to be reversed any time soon.


I would edit above sentence to say “Argentina, Indonesia, Malaysia, Thailand, Russia, Brazil, Mexico, the United States, the United Kingdom, Germany, Finland, Sweden, Norway, China and Italy suddenly started growing after they devalued, Greece might not.”

Further reading of Wikipedia would probably allow me to double the length of the list but those are just the ones I could think of off the top of my head.

Posted by johnhhaskell | Report as abusive

The curious Greek bond price chart

Felix Salmon
Jul 26, 2011 15:29 UTC


Many thanks to Van Tsui and Scott Barber for putting this chart together for me. We’re all used to seeing yield curves — charts which show the yield, for any given credit, at various points along the maturity spectrum. This chart is different: it’s a price curve. It just shows the price at which Greek bonds are trading, plotted according to their maturity.

And it’s really odd.

To understand just how odd this chart is, it’s important to realize that in the Greek bond exchange, there’s only one menu of options for anybody holding a Greek bond. It doesn’t matter if your bond is maturing in six months or if it’s maturing in 26 years, the instruments you’re given the choice of swapping into are all exactly the same.

The way that the bond exchange has been structured, the new Greek bonds are all going to trade at roughly the same price, at least in the first instance. If they didn’t, then everybody would simply pile into the most valuable instrument. We won’t know exactly what price they’ll be trading at until they start changing hands, of course, but I’ve marked a range between 62 and 75 cents on the dollar in the chart. At 62 cents on the dollar the bonds would be trading at an exit yield of 13%; at 75 cents on the dollar they would be trading at an exit yield of 9%. Chances are, when the bonds start trading, they’ll be somewhere in that range.

For the bonds which are trading at or near that range, the exchange makes sense. You swap one bond for another bond worth pretty much the same amount, and Greece gets a bailout at the same time. Net-net, you’re better off.

But for bonds trading significantly above 75 cents on the dollar, there’s a lot of reason to stay out of the exchange. We’re talking the bonds maturing in the next year or two here — for them, you’d be much better off holding them to maturity, or even just selling them on the secondary market.

Odder still are the bonds trading at very low prices, below 40 cents on the dollar, or, in some cases, below even 10 cents on the dollar. What on earth are they doing down there?

All of those bonds can be tendered into the exchange for new bonds which are likely to be worth at least 60 cents on the dollar: it’s free money. Just buy a long-dated low-coupon Greek bond, tender it into the exchange, sell your new bond, and double your money. Why hasn’t that price difference been arbitraged away? And, more generally, why aren’t the blue dots all arrayed in a nice straight line at roughly the level the market expects the new bonds to trade at?

I suspect that what’s going on here is that we’re seeing artifacts of an extremely illiquid market. Over the past year or so, as the Greek fiscal crisis got steadily worse, mark-to-market bond investors sold their bonds to banks, who were willing to pay a premium for them, partly because they were eligible to be used as collateral at the ECB. And the banks are holding on to their Greek bonds now, promising to tender them into the exchange. As a result, there’s no real liquid market in Greek bonds any more, and the prices seen in this chart aren’t available to any old bond investor looking for a quick flip.

Embedded in that mechanism is an implied quid pro quo. The banks will make a lot of money, at least on a mark-to-market basis, by tendering their long-dated Greek debt. In return for that profit, they will tender their short-dated Greek debt as well, even though doing so doesn’t make a lot of rational sense.

This helps explain why the official description of the bond exchange splits the par bond into two seemingly identical parts: a “Par Bond Exchange” where bondholders get a new 30-year bond with a step-up coupon rising from 4% to 5%; and a “Par Bond offered at par value as a Committed Financing Facility,” where bondholders roll maturing bonds into exactly the same thing.

Why make a distinction between the Par Bond Exchange and the Par Bond offered at par value, when both involve swapping your old bonds for the same new 30-year bond? Because the second one, the Committed Financing Facility, can be spun by the banks as them putting new money into the deal. And in a certain sense they are: they’re voluntarily giving up the extra money they could get by holding or selling their short-dated Greek debt.

All of this is in one sense much more complicated than it needs to be. Why construct a hidden and implicit quid pro quo, when you could do a normal bond exchange instead, and swap existing debt into new debt of similar or slightly higher value? Greek bonds, as the chart clearly shows, are worth anywhere from 10 cents on the dollar to 110 cents on the dollar: why should they all be swapped into the same thing?

On the other hand, this is at heart an old-fashioned London Club debt restructuring, as opposed to an Argentina- or Ecuador-style bond exchange. Bondholders look at their holdings on an instrument-by-instrument basis, while bankers are more prone to thinking about their exposure to any given credit as one big risk to be restructured.

So this exchange might well work, insofar as Greece’s debt is overwhelmingly held by banks. But don’t think of it as a template for future restructurings.


“Embedded in that mechanism is an implied quid pro quo. The banks will make a lot of money, at least on a mark-to-market basis, by tendering their long-dated Greek debt. ”
Except most of these bonds aren’t marked to market by the banks. In many countries, even where they are held as available for sale, they don’t take any capital hit/gain from MTM. So they’re going to take a hit from realising the par loss.

Posted by GingerYellow | Report as abusive

Adventures with Greek restructuring math

Felix Salmon
Jul 26, 2011 14:23 UTC

What does it mean, when a bank takes a 21% haircut on its Greek debt? With the release of Deutsche Bank’s results yesterday we have an interesting case in point: the bank took an impairment charge of €155 million on its Greek government bonds. That’s just under 10% of Deutsche Bank’s stated €1.6 billion in Greek sovereign exposure.

Deutsche Bank is well aware of the size of the haircut, of course — but not all of its Greek exposure comes in the form of securities classified as “financial assets available for sale.” Still, it would have been nice to have been told the size of the writedown in percentage terms, rather than just in cash terms.

Part of the problem here is that the exchange offer is rather opaque; Joseph Cotterill says that the structure of one of the discount bonds, in particular, is “still stumping analysts.” Here’s how the IIF describes it:

A Discount Bond Exchange offered at 80% of par value for a 15 year instrument. The principal is partially collateralized with 80% of losses being covered up to a maximum of 40% of the notional value of the new instrument. The collateral is provided by funds held in escrow. These funds are borrowed by Greece from the EFSF. The EFSF funding costs are covered by the interest earned on the funds in the escrow account so there is no funding cost to Greece of this collateral. The funds in escrow are returned to the EFSF on maturity, if not used, and the principal on the bond is repaid by Greece.

Let’s say you swap €1,000 face value of Greek debt into this new instrument. The first thing that happens is that you take a haircut: the new bond, which carries a coupon of 5.9%, will have a face value of only €800.

The second thing that happens is that Greece will borrow 40% of that sum — €320 — from the EFSF, the European bailout fund. It will put that money into an interest-bearing escrow account; the interest on the money will be enough to repay the interest that the EFSF is charging Greece.

And this is where things become unclear. In the event that there are “losses,” then 80% of your losses will be repaid out of that escrow account.

But what does that mean? My first thought was that it was something to do with a possible second haircut. Say bondholders were asked to take another 10% haircut on the new bond. That would be €80, and of that €80 the escrow account will repay you €64, which means your actual haircut would only be €16, or 2%. This continues up until the losses reach 50% of the value of the new bond, and the escrow account pays out in full. After that, there’s no money left and all further losses you suffer entirely.

That would be quite elegant, since it’s unlikely Greece would impose a second haircut of much more than 50%. But then I realized that coupon payments are just as important as the face value of any principal. If you reduce the principal by 10% and the coupon remains the same 5.9%, then you lose 10% of all your coupon payments, too. Let’s say there are 12 years left on the bond when the second restructuring happens — then a 10% haircut wouldn’t just knock €80 off your principal repayments, it would also knock €57 off your total coupon payments. Presumably 80% of that, or another €45, would also have to come out of the escrow account.

So now the escrow account is looking rather thin. Let’s say there’s another restructuring after 3 years with a more realistic 30% haircut, and the coupon staying at 5.9%. Then the escrow account loses €192 in principal and another €135 in interest, for a total of €327. We’ve already exceeded the amount of money in the account — it’s wiped out.

And the other question, of course, is when the money would be paid out of the escrow account. Would it pay out at the time of restructuring, even for payments which aren’t due for another decade or more? Or would it just sit there in escrow, paying out little €5.66 partial-replacement coupons every six months until it ran out of money? It’s a big difference, since €5.66 today is worth a hell of a lot more than €5.66 in ten years’ time.

I’m sure answers to these questions will slowly emerge — but for the time being, if you’re a bank tendering into the exchange, I think you can more or less write down your bonds by any vaguely plausible amount you like, and probably get away with it. If you’re marking to market, of course, it’s easy. But if you’re holding old Greek debt on your books at par, then — especially if you swap into another par bond — you probably have very wide latitude in where you mark the new debt. And if you swap into a discount bond, for the time being almost no one understands exactly what that’s reasonably going to be worth.

Update: Thanks to my commenters, especially Greycap, for pointing out that it’s just the principal, not the coupon payments, which are partially collateralized. But in a way this only makes things much worse. If Greece wants to restructure the bond, it will now have every incentive to push back maturities and reduce coupons to zero, rather than other options — because that wouldn’t trigger a payout of collateral. It seems very easy to game to me.


This article was -and continues to be, thanks to the commenters- a primary resource to me in digging deeper with the IIF article. Although I’m not clear as of now on all the aspects of the offer, I’d like to thank to all the contributors of this debate.

Posted by kahmet | Report as abusive

The CDS market and Greece’s default

Felix Salmon
Jul 22, 2011 13:46 UTC

ISDA has made the right decision: the Greek bond default does not and should not count as a “credit event” for the purposes of whether Greek credit default swaps will get triggered.

This is the right decision for two reasons. Firstly, the swap is voluntary. If you don’t want to suffer a haircut, or see your six-month maturity suddenly become a 30-year maturity, then all you have to do is nothing. If the CDS paid out, that would be tantamount to giving free money to anybody who wanted it: just buy short-dated Greek debt and also credit protection on that debt. The bonds will pay out in full, and the CDS would pay out as well.*

Secondly, this should be a large nail in the coffin of the CDS market generally. Credit default swaps were designed primarily for banks: it took many years before they became widely-traded speculative instruments in their own right. The idea behind them was that banks could keep loans on their balance sheets while at the same time hedging the risk that they would default. That was easier and cheaper than selling the loans outright, and also helped banks maintain good relations with their borrowers.

In the case of Greece, however, banks are going to take a 21% haircut on their loans to the country — and if they hedged themselves in the CDS market, too bad. Whatever they paid for their CDS protection — and if they bought it recently, it could be quite a lot of money — will not help them one bit. If buying CDS doesn’t help you in the event of a default, then there’s really no point in buying CDS.

So even though there isn’t going to be a formal credit event in Greece, have no doubt that this is a default — or, at least, that it will be a default if the banks are correct in anticipating a participation rate of 90%. But I have to say I’m surprised they’re so bullish, and I will be extremely impressed if Greece wakes up one morning to find that 90% of its private-sector debt has been tendered into the exchange.

For one thing, the exchange is structured in a pretty unsophisticated way. No matter whether you have a bond maturing tomorrow or a bond maturing in a decade, you’re swapping it into exactly the same 30-year instrument. Banks with short-dated Greek debt aren’t going to be happy about this, and will have a strong incentive to quietly sell that debt on the secondary market to someone willing to just hold it to maturity.

And more generally, it’s almost impossible to see why anybody who isn’t a bank would tender into this exchange. If you’re an individual holding Greek bonds, or a big bond investor like Pimco, the obvious thing to do is to hold on to your debt for the time being, since the exchange includes no carrots and no sticks. The only incentive for you to tender into the exchange is that the new bonds will be partially collateralized with zero-coupon 30-year bonds. Triple-A-rated 30-year bonds in euros currently yield 4%, which means that the collateral in the new Greek instruments will be worth less than 31 cents on the dollar. And so far, there’s been zero indication that holdouts will get anything less than all their money back, in full and on time; they might have a bit less liquidity, but bond investors are used to illiquid instruments.

Is it really the case that over 90% of Greek bonds are held by banks which will tender all of their Greek debt into the exchange? Maybe so; non-bank investors looking to go long Greek credit might well have found it easier and cheaper to do so by writing credit protection in the CDS market rather than buying cash bonds. In which case they’re smiling broadly today.

If that’s the case, then maybe this deal is one of those rare occasions where the CDS market was genuinely useful. Back in the 1980s, when sovereign debt was held overwhelmingly by banks, negotiations about restructuring that debt could be held with the London Club of bank creditors. Non-bank investors didn’t really matter. But then the loan market became a bond market, and investors in sovereign debt were mainly non-banks; no longer were negotiations even really possible.

Now, however, we seem to have come full circle: banks are able to put together bond-restructuring deals on their own, without worrying much about non-bank bond investors. And one reason would seem to be that the non-bank investors have largely moved from the bond market to the CDS market.

Is this scheme going to work? There’s a big collective-action problem at the banks, and an even bigger problem with the non-banks. So the 90% target is ambitious. But so far I haven’t seen much doubt. I will say this: if the 90% target is achieved, then the Institute for International Finance will deserve a lot of credit. I’m no fan of the organization — I’ve been very rude about it for many years. But if it manages to pull this off, it will finally and genuinely have justified its existence.

*Update: Kid Dynamite asks a good question in the comments: if the bonds paid out in full, wouldn’t the CDS auction clear at par, with the CDS paying out nothing? No. To a first approximation, the CDS auction clears at the price of the cheapest-to-deliver Greek bond, and Greek bonds are trading at a substantial discount. The cheapest-to-deliver bond will probably have a very long maturity, and if there was a credit event for CDS purposes, then holders of credit default swaps would get a nice check in the mail.


“banks are going to take a 21% haircut on their loans to the country — and if they hedged themselves in the CDS market, too bad”
CDS may (and shall) not be triggered, but I don’t think banks are writing down hedged bonds — unless they voluntarily participate of course.
Too early to say, though.

Posted by vastunghia | Report as abusive

Greece defaults

Felix Salmon
Jul 21, 2011 22:39 UTC

The latest Greek bailout is done — the official statement is here — and it involves Greece going into “selective default,” which is, yes, a kind of default.

I can’t remember a major financial story which has been covered so inadequately by the financial press. All the incomprehensible eurospeak seems to have worked, along with the fact that the deal was announced in Brussels, where the general level of journalistic financial literacy is substantially lower than it is in London or New York or Frankfurt. On top of that, statements are coming from so many different directions — Eurocrats, heads of state, the Institute of International Finance, Greek officials, Portuguese and Irish officials, you name it — that it’s extremely hard to put it all together into one coherent whole.

Oh, and to complicate things even further, most of the day’s discussion was based on various widely-disseminated draft documents which differed substantially from the final statement.

This is a bail-in as well as a bail-out: while Greece is getting the €109 billion it needs to cover its fiscal deficit, both the official sector and the private sector are going to take losses on their loans to the country.

As such, it sets at least two hugely important precedents. Firstly, eurozone countries will be allowed to default on their debt. Secondly, a whole new financing architecture is being built for Greece; French president Nicolas Sarkozy called it “the beginnings of a European Monetary Fund.”

The nature of massive precedent-setting international financing deals is that they never happen only once. There’s lots of talk today that this deal is for Greece and for Greece only, but some of the more explicit language to that effect was excised from the final statement. On thing is for sure: these tools will be used again, in future. They will be used again in Greece, since this deal is not enough on its own to bring Greece into solvency; and they will be used in other countries on Europe’s periphery too, with Portugal and/or Ireland probably coming next.

As far as the public sector is concerned, the European Union will do four main things. First, it will extend the maturities on Greece’s debt from the current 7.5 years to somewhere between 15 years and 30 years: the loans that the EU is currently giving Greece aren’t designed to be repaid, in some instances, until 2041.

Second, the interest rate on those loans will be extremely low — essentially, Greece is getting those EU funds at cost, currently about 3.5%. The EU is also extending these ultra-low financing rates to Portugal and Ireland, so as not to implicitly punish countries which don’t default.

Third, the EU will put together its own stimulus plan for Greece. The phrase “Marshall Plan” was taken out of the final statement, but there’s still talk of “mobilizing EU funds” and building “a comprehensive strategy for growth and investment.” This is vague, of course, but it does at least constitute an attempt to help Greece through a period of very painful austerity.

Fourth, the Maastricht treaty will get resuscitated, with all eurozone countries except Greece, Ireland and Portugal committing to bring their deficit down to less than 3% of GDP by 2013. Paul Krugman is screaming about this, but this was a central part of the eurozone project from the get-go, and clearly the eurozone needs some kind of fiscal straitjacket for its constituent members to prevent the rest of them from running up enormous deficits and then getting bailed out by Germany.

Finally, the EU will provide “credit enhancement” for Greece’s private-sector bonds. This is a central part of the default plan, and it looks a lot like the Brady plan of the late 1980s. The official statement from the IIF, which is representing private-sector creditors in this matter, is a little vague, but essentially if you’re a holder of Greek bonds right now, you have three choices.

  1. You can do nothing, and hope that Greece pays you in full and on time.
  2. You can extend your maturities out to 30 years, and accept a modest coupon of 4.5%; in return, your principal will be guaranteed with an embedded zero-coupon bond from an impeccable triple-A-rated EU institution, probably the EFSF.
  3. You can extend your maturities out to 30 years, take a 20% haircut, and get a higher coupon of 6.42%; again, the principal is guaranteed with zero-coupon collateral.
  4. You can extend your maturities out to 15 years, take a 20% haircut, get a coupon of 5.9%, and have only a partial principal guarantee through funds held in an escrow account.

The first option is by far the most interesting. No one has come out and said that Greece is going to default on bondholders who don’t exchange their bonds; instead, there’s just a lot of arm-twisting of big banks to do all this “voluntarily.” But that won’t stop the credit rating agencies giving Greece’s bonds a default rating — this is a coercive deal, which clearly reduces the value of banks’ Greek debt. (After all, just look at those haircuts.)

Is it possible for other bondholders — those who haven’t had their arms twisted — to free-ride on the back of this deal and continue to get paid in full? I suspect that it probably is. Which is one reason why this Greek restructuring won’t be the last.

Overall, this looks like a deal which can quite easily be scaled up and used as a framework for future default/restructurings. I don’t know if that’s the intent. But there’s nothing here to reassure holders of Portuguese and Irish bonds — or even Spanish and Italian bonds, for that matter — that they’re home safe. Greece will be the first EU country to default on its debt. But I doubt it’ll be the last.


If Greece defaults, it won’t be the first government to renege on its financial obligations, but its failure would set a new record, both for scale and complexity.

At the moment, the dubious honour of biggest deadbeat goes to Argentina, which failed to make good on its government debts in December 2001, to the tune of about $100 billion US.
but yes its quite important that What Will Be Outcome Of Greece Debt Crisis. http://www.abnglobalonline.com/what-will -be-outcome-of-greece-debt-crisis/

Posted by CienMichel | Report as abusive

Why Lagarde got the IMF job today

Felix Salmon
Jun 28, 2011 22:21 UTC

For me the interesting thing about Christine Lagarde becoming the new managing director of the IMF is not the news itself. I said she’d get the job as long ago as May 15, and I’ve considered her a lock since May 20. Rather, the interesting thing for me is the timing: everybody expected the announcement on Thursday, the 30th, but instead it came today, the 28th. Why push things up?

Because in the fraught negotiations with Greece, every day counts — the IMF disbursement was originally due tomorrow, the 29th, and can’t wait much longer than that before Greek debt maturities in July start piling up and forcing a default. And the headless IMF, it turns out, has not been an effective actor in those negotiations. Here’s Mohamed El-Erian, an old IMF hand:

The post of managing director is not to be taken lightly in an institution that operates like a well-disciplined army, with staff looking up to the unquestioned general for decisive leadership.

This is why the resignation of Dominique Strauss-Kahn has been so disruptive to the functioning of the IMF.

With Lagarde now moving swiftly from an international campaign to actual management of the Fund, the world’s technocrats will all be hoping that she will prove a forceful and decisive leader on the urgent subject of Greece. The Greeks have a certain amount of freedom here, since it’s pretty much unthinkable that Lagarde’s first act would not be to disburse bailout funds. But one sign of a leader is getting results even when your actions are severely constrained. Lagarde has an immediate opportunity to prove herself, and it’s absolutely in Greece’s long-term interest to make her look tough and effective. She might well put these extra two days to very good use.


Not really true: June 30 was the end-deadline set from the beginning by the board, but the announcement has been expected on June 28 for at least a week. And CL won’t be in the chair until Tuesday next week, so it’s not as if two days this week made much difference.

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Greece’s messy muddle-through continues

Felix Salmon
Jun 24, 2011 16:22 UTC

The one thing you can be sure of, when it comes to the latest episode in the ongoing saga of the Greek bailout, is that it’s a mess. The WSJ is reporting that the bailout is secure, while Reuters is a bit more cautious, just saying that a deal is “closer”. Everybody knows what needs to happen — but a crucial vote in the Greek parliament still hasn’t happened, and the role of private-sector banks going forwards is also extremely vague:

European banks and finance officials are discussing a proposal to replace existing Greek debt with a different type of bond to get around ratings agencies’ reservations about a planned rollover, two senior European banking sources said on Friday.

The proposal foresees a voluntary rollover of debt into securities of a different and not comparable credit composition to avoid agencies moving Greece to default status, the sources told Reuters on Friday.

“Only by a completely different composition of the bonds would the rating agencies see the restructuring as voluntary and not declare Greece insolvent,” said one senior banker.

Your guess is as good as mine when it comes to the meaning of “completely different composition”, but it sounds a bit like some kind of latter-day Brady bond, with principal guarantees or a rolling interest guarantee or some kind of participation from the EU, perhaps provided by the European Financial Stability Facility. Banks would happily swap Greek debt for bonds partially guaranteed by the EFSF, because such bonds would be more creditworthy; meanwhile, the swap wouldn’t be considered a default, since the exchange would be entirely voluntary.

But we’re not there yet, and in any case such a deal would only be a waystation on the road to a restructuring. Crucially, markets would look very hard at any collective action clauses written into the new debt, to see whether French and German banks, their arms twisted by their governments, could essentially cram a significant haircut onto other bondholders not subject to the same degree of moral suasion.

At some point, inevitably, a Greek restructuring is going to get ugly and fractious. But for the time being, it’s just messy. And we can stay in this muddle-through zone for a long time, while market participants position themselves for the inevitable dénouement. Let’s just hope that technocrats in Greece and the EU are getting their ducks in a row as well.


“completely different composition” — instead of being backed by the full faith and credit of the Greek government (it not being valued very highly at the moment), the bonds will be backed with Greek government real estate holdings. That’s right, you too can own a partial claim to The Acropolis! Of course, most of the property backing the paper will do so at wildly inflated prices due to fraudulent appraisals. Thus will the Greek debt crisis come to mirror the US financial meltdown in all the particulars (rather than just some of them, in a general way).

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