Felix Salmon

Worrying about Greece’s CDS for the wrong reasons

Felix Salmon
Mar 2, 2012 15:13 UTC

Harry Wilson today outs Allen & Overy’s David Benton as the legal mastermind behind the mess that is sovereign CDS documentation. Benton’s certainly coming under a lot of criticism these days, and not just on the ultra-wonky end of the spectrum from people like me. Even Pimco’s Bill Gross seems to have a beef with these rules — and Pimco’s on the Determinations Committee!

“If I were a buyer of protection on Greece and have seen the result this morning in terms of no protection, then I would be upset,” Gross, manager of the world’s largest bond fund, said on CNBC television of the ISDA’s decision.

So when Wilson says that ISDA’s decision not yet to declare default was “controversial”, he’s not wrong. Here, for instance, is Barry Ritholtz:

Here is a question for the crowd: Exactly how brain damaged, foolish and stupid must a trader be to ever buy one of these embarrassingly laughable instruments called derivatives?

The claim that Greece has not defaulted — despite refusing to make good on their obligations in full or on time — is utterly laughable.

And Peter Eavis is back with more CDS criticism, too:

One of the decisions of the swaps association on Thursday underscored how swaps can be disconnected from actions that harm investors’ economic interests. As part of the Greek debt deal, the European Central Bank will be shielded against losses on the Greek bonds it holds, a move that relegates, or subordinates, the claims of private creditors who hold the same bonds.

But the swaps association said the plans to subordinate private creditors do not meet the definition of subordination in the swaps contracts, so they do not have to pay out.

All of which says to me that ISDA and Greece have done an incredibly bad communications job here. Because ISDA’s decision was, clearly, the correct one.

The point here, which is easy to miss, is that credit default swaps only get triggered when there’s a real-world event of default. Yes, the deal with the ECB is indeed going to subordinate private-sector bondholders. And yes, Greece is indeed going to fail to make good on its obligations come March 20. There will be an event of default in Greece. But swaps don’t pay out on future events. They pay out on past events. And Greece hasn’t actually defaulted yet: every payment it has promised to make has, to date, been made in full and on time.

Now there are exceptions to this rule. If a government explicitly repudiates its outstanding debt, then that can count as an event of default even before a payment is missed. But Greece hasn’t actually done that. And most of the time, default swaps only pay out when there’s a default. Which is as it should be.

Is that reason for bondholders to be upset, pace Gross? Absolutely not. If you own a credit default swap on Greece, you own a piece of paper worth about 75 cents on the dollar. If you want to realize that 75 cents right now, you can: you can just sell your CDS. If and when the CDS is officially triggered, there will be an auction, and the CDS will be found to be worth roughly 75 cents on the dollar. In that case, you will wind up with 75 cents whether you like it or not.

In other words, when Greece finally defaults, owners of credit protection will be forced to get a payout. Whereas those owners right now have the option: they can take the payout if they want it, or they can hold on to their CDS position if they would rather do that. I don’t see why having that option would make anybody upset.

This is why the CDS market has been so successful: it’s a liquid, market instrument, which prices in expectations of future default. Ritholtz is right that Greece has refused to make good on its future obligations. And as a result, default protection on Greece is extremely valuable. When that future date comes and goes without a bond payment, the CDS will get triggered, and holders of protection will get a lot of money. There’s nothing broken there.

The subordination question is a bit messier, but it’s fundamentally the same idea. Greece has now created two classes of bonds: the ones held by the ECB, and the ones held by private bondholders. There’s nothing in the documentation of those bonds which might indicate the ECB’s bonds are senior to the private sector’s bonds. Right now, they’re all, legally, pari passu.

Again, in future, that’s not going to be the case. Greece is going to privilege the principal and coupon payments to the ECB, while imposing a massive haircut on the payments due private bondholders. That’s both subordination and an event of default. And when it happens, the CDS will get triggered. And that trigger is priced in to the CDS market.

In many ways it’s the genius of the CDS market — at least in theory — that there’s no rush to trigger CDS, because if you know that the instrument is going to get triggered very soon anyway, it’s going to be worth pretty much the same today as it will be when it’s triggered.

That’s my problem with the way ISDA rules cover bonds covered by CACs. Because of technical issues surrounding the availability of deliverables, it’s possible that if you wait for the default to happen, you’ll be too late to get what by rights should be your payout on the bonds. But this is a separate issue from what Gross and Ritholtz and Eavis are worrying about. They seem to think one of two things: either that Greece has already defaulted, and that therefore the CDS should have been triggered by now, or else that a Greek default is so certain at this point that the CDS should have been triggered by now. The first isn’t true. And the second is silly.

Eavis has another point, which is that default swaps are used for a purpose, and that purpose is to hedge against falling bond valuations. (That’s what he means by “investors’ economic interests”.) He is worried that the payout on the bonds might not be entirely in line with the loss of value on the bonds. And that’s a reasonable worry. But it’s also, right now, a pretty theoretical worry. Because in practice, the value of Greek CDS has tracked the value of Greek bonds extremely closely. In other words, even if there are possible problems with them in theory, they seem to have worked OK in practice.

I’ve got a few questions for ISDA about the way that CDS documentation works in the sovereign context in particular, and I’ll be wonking out about this issue further going forward. Because I think that the combination of CACs and CDSs is potentially extremely dangerous. But what I’m emphatically not worried about is ISDA’s decision not to trigger the CDS just yet. That decision was exactly correct. Even Pimco voted for it.


good explanation of the contractual realities and subsequent negotiations

and the key message needs to be repeated:

(quote, felix) “Greece hasn’t actually defaulted yet: every payment it has promised to make has, to date, been made in full and on time… If a government explicitly repudiates its outstanding debt, then that can count as an event of default even before a payment is missed. But Greece hasn’t actually done that. And most of the time, default swaps only pay out when there’s a default. Which is as it should be.”

Posted by scythe | Report as abusive

Understanding Greece’s default

Felix Salmon
Mar 1, 2012 15:08 UTC

First, apologies for how Greece-heavy this blog is these days. There are other things going on out there, I’m sure. But we’re going through the largest sovereign default in the history of the world, and surprisingly few people — including senior European policymakers and journalists who are covering it professionally — really seem to understand what’s going on.

At the WSJ, for instance, the news story on today’s official ISDA determination (“Greek Deal Won’t Trigger CDS Payouts, Panel Says”) is bad; the blog post about it by Charles Forelle (“ISDA’s Greek Ruling Not the Last Word”) is very good.

And in Europe, the range of sophistication within policymaking circles is even greater. At the lowest, most basic level, one finds a feeling that it’s a Bad Thing if a European sovereign nation were ever to default, and so therefore it would be a good thing if the bond exchange was organized so that there was no official market determination of default. (Never mind that Greece is already in selective default on its bonds, according to S&P.)

At a slightly higher level of sophistication one finds the short-sellers-are-bad crowd, who don’t like CDS because they allow hedge funds to easily bet against countries. If the messy Greek CDS situation helps to reduce the amount of trust that the markets have in sovereign CDS generally, then so much the better, on this view.

And then, finally, there’s Peter Eavis’s conspiracy theory: if the Greek bond exchange goes really smoothly, and the sun rises in the morning and Italian bond yields stay below 5%, then maybe that’s the most worrying outcome of all. Because at that point Greece will have managed to wipe out, at a stroke, debt amounting to some 54% of GDP. You can see how Portugal and Ireland might be a little jealous. You don’t want to make sovereign default too easy — not least because it would do extremely nasty things to European banks’ balance sheets.

That said, Greece has now broken the sovereign-default taboo; many countries both inside and outside Europe have way too much debt; and now that debt relief is an option for politicians to seriously consider, it’s pretty much certain that at some point another European government will end up choosing that option.

So it’s extremely important for European politicians and voters generally to really understand what’s going on here, rather than just a relative handful of financial-market sophisticates. Greece’s default was a drastic move, and Europe has semi-officially said that it was a mistake: once we’re done with Greece, they’ve said, we’re not going to ask any other European country to similarly write down its private debt.

But the cat’s out of the bag now. Greece had no choice but to default. Portugal and Ireland do now have the choice. And while the cost of default is large, so is the cost of carrying a whopping great debt load. It’s up to the leaders and voters of those countries to determine which is the least bad option.


Yep – Greece’s default is Pandora’s Box. The lid is open and you can’t shut it now. This is going to bring down the entire financial order of the West because there isn’t enough moolah to cover all the sovereign defaults that are just waiting in the wings.

All we did 3 and 1/2 years ago was transfer to the sovereigns the massive private debt that defaulted in the crash of 2008. That is now breaking the camel’s back, since most over-developed sovereigns were already on trajectory toward having their backs broken before the crash of 2008 came along.

It’s ‘prophetic’, if you will, that the collapse of western democratic capitalism should begin, be triggered by, the default of Greece, the Mother of Democracy. It’s 1989-1991 for western capitalism.

Posted by NukerDoggie | Report as abusive

How Greece’s default could kill the sovereign CDS market

Felix Salmon
Feb 29, 2012 23:26 UTC

Alea today posts the timeline for physical settlement of credit default swaps, once a credit event has been declared. He doesn’t say why he’s posting it, but the main thing to note is that it’s likely to take a couple of months between (a) the credit event being declared in Greece, and (b) the final settlement of all credit default swaps on Greece.

And that, in turn, reveals a significant weakness in the architecture of CDS documentation. It may or may not be a big deal, this time round. But market participants have already been spooked by the possibility that Greece might be able to default without triggering its CDS at all. Now they can add to that another worry: that Greece might be able to default in such a manner as to leave the ultimate value of the CDS largely a matter of luck.

The way that CDS auctions work, you start with a credit event. Then, using an auction mechanism, the market works out what the cheapest bond of the defaulting issuer is worth. If it’s worth, say, 25 cents on the dollar, then people who wrote credit protection end up paying 75 cents to the people who bought protection: that’s equivalent to the people who bought protection getting 100 cents on the dollar, and handing their bonds over in return.

With Greece, however, the bond exchange is going to complicate things — a lot. Remember that it has a natural deadline: March 20, when a €14 billion principal payment comes due. If Greece’s old bonds haven’t been exchanged for new bonds by that point, then things will get even uglier, and even more chaotic, than anybody’s expecting right now. So it’s very much in Greece’s interest, and Europe’s more generally, to have everything wrapped up by March 20. Bondholders too, truth be told — they hate uncertainty.

But then there’s the CDS holders. In the best-case scenario for Greece and Europe and bondholders, every €1,000 of old Greek bonds will get converted to new bonds with a face value of just €315. Those bonds will probably trade at about 30% of face value, which means the new-Greek-bond component of the exchange will be worth about 10 cents for every dollar in face value of old Greek bonds that you might currently hold. Add in another 15 cents of EFSF bonds, and the total value of the exchange will be about 25 cents on the dollar, which is why people are talking about a 75% “present value haircut”.

The important thing, here, is that Greece is issuing new bonds worth around 10 cents on the dollar, while the EFSF is issuing new bonds worth around 15 cents on the dollar. The structure of the new Greek bonds is secondary: these ones involve a nominal haircut of 68.5%, and a market price of about 30 cents on the dollar. But theoretically, Greece could have constructed bonds with a significantly higher coupon and a bigger nominal haircut — maybe the haircut would be 85%, with the bonds trading at 67 cents on the dollar. Bondholders would still receive about €100 worth of new Greek bonds for every €1,000 of old Greek bonds they hold. But instead of the new Greek bonds trading at 30 cents, they’d trade at 67 cents.

Why does it matter what the nominal price of the new Greek bonds is, so long as the total package, including EFSF bonds, is worth about 25 cents on the dollar? Economically speaking, it doesn’t. But for the purposes of the CDS auction, it matters a great deal.

The reason is that the key number in the auction is the nominal value of the cheapest-to-deliver Greek bond — that’s the price at which the auction clears. And here’s the rub: this auction is going to take place after March 20, after the old Greek bonds have been exchanged into new securities. Because Greece intends to use collective action clauses to change the terms of all its outstanding bonds, even if they’re not tendered into the exchange, there effectively won’t be any old bonds in existence by the time the CDS auction happens. The only outstanding reference securities will be new bonds.

In the auction, market participants will not be bidding on the value of the package that is being offered in return for every old bond. The new EFSF bonds are obligations of the EFSF, for instance: they’re not obligations of Greece, and they have no place in a Greek CDS auction.

The way that CDS auctions are meant to work is that once a borrower defaults on its debt, that defaulted debt continues to be traded in the market, and its value then determines the amount that credit default swaps need to pay out. But in this case, Greece’s defaulted debt might well not continue to be traded in the market. In which case, when traders need to find a cheapest-to-deliver bond to bid on in the CDS auction, they’re going to have to use one of the new bonds, rather than one of the old ones.

And now you can see why the nominal price of the new Greek bonds is so important. Right now, it seems that they’ll be trading at a nominal price of about 30 cents on the dollar, which is close (ish) to the current market price of the old Greek debt. But there’s no particular reason why that should be the case. If Greece had gone for an 85% nominal haircut rather than a 68.5% nominal haircut, then the nominal price of the new Greek bonds would be 67 cents on the dollar — and anybody who wrote credit protection on Greece would only have to pay out 33 cents on the dollar rather than 70 cents on the dollar.

In other words, Greece’s CDS really aren’t protecting holders of Greek bonds at all — or if they do, it’s more a matter of luck than of law. When they get paid out on their CDS holdings, people owning protection against a Greek default won’t get paid according to how much money they lost on their old bonds. Instead, they’ll get paid according to the nominal price of the new bonds.

What this means is that the CDS architecture is broken, and can’t cope with collective action clauses. And as a result, according to the hedge fund manager who tipped me off to the whole problem, “this Greece CDS imbroglio might be the final blow for sovereign CDS as a product.”

Now there is a possible solution here: ISDA could try to decree, somehow, that the total package bondholders receive in return for their old bonds will count as a deliverable security for the purposes of the CDS auction. Bundle up the new bonds, the EFSF bonds, the GDP warrants, everything — and that bundle can be bid on in the auction, to determine where the CDS pays out. That would be fair and right. But the problem is, it might not be legal. There’s really nothing in the ISDA CDS documentation which explicitly allows that to happen.

The whole point about credit default swaps is that they’re meant to behave in a predictable manner in the event of default; one thing we know for sure about Greece is that the behavior of its CDS is going to be anything but predictable. We don’t even know for sure whether they’ll be triggered, let alone what they’ll be worth if and when they are.

Now there are a lot of people, among them European policymakers, who would actually be quite happy if the Greek default killed off the sovereign CDS market as a side effect. But I actually believe that sovereign CDS, when they work, are rather useful things. It’s just that Greece is having the effect of showing that they don’t necessarily work. And if you can’t be sure that they’ll work when triggered, there’s really no point in buying them at all.


The answer to this problem is straightforward: Invent a new product to serve as “insurance” (quotes to avoid its regulation like actual insurance, which requires capital) on the CDS in question.

More fees, more paper, more “robust” (in quotes because it means “without capital”) financial system.

Innovation will solve all problems. (I mean, “innovation.”)

Posted by Eericsonjr | Report as abusive

Greece’s default gets messier

Felix Salmon
Feb 28, 2012 19:47 UTC

Back on February 17, the European Central Bank sprinkled its magical pixie dust on its Greek sovereign bonds, with the effect that they effectively ended up exempt from the restructuring and haircut being inflicted on everybody else. I wasn’t very excited about this development at the time:

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

Today, we’re beginning to get a hint of the messiness that this decision caused.

First, there’s a formal question which has been put to ISDA’s Determinations Committee, asking whether the ECB magical pixie dust, combined with the passage of the Greek law to allow the haircut, doesn’t in itself constitute a credit event under ISDA rules.

The question takes the form of a single 179-word sentence, which some lawyer somewhere probably thinks is very clever. But here’s the idea: the two events together have effectively cleaved the stock of Greek bonds into two parts, with one part (the bonds owned by the ECB) being effectively senior to the other part (the bonds owned by everybody else). This is known as Subordination, and Subordination is a credit event under ISDA rules.

Now there’s no doubt that the private sector’s Greek bonds are de facto subordinate to the ECB’s Greek bonds now, and that they weren’t subordinate a couple of weeks ago. But so far there’s nothing de jure about this subordination — there’s no intrinsic reason why bonds with CACs, for instance, should be subordinate to bonds without CACs. So my guess is that this request is going to go nowhere, and/or get overtaken by events.

But now there’s news that another European institution has managed to get its hands on the ECB’s magical pixie dust.

The European Investment Bank, owned by the 27-member bloc, is getting exemptions from Greek debt writedowns in the same way as the euro area’s central bank, according to two regional officials familiar with the matter.

The European Central Bank negotiated a deal to avoid the 53.5 percent loss on principal that’s costing private investors as much as 106 billion euros ($143 billion). The EIB, which unlike its Frankfurt-based counterpart represents the entire European Union, also owns Greece’s debt and is sidestepping the so-called haircut in the same way, said the officials, who declined to be identified because the plan isn’t public.

While the ECB exemption was understandable, on the grounds that the ECB was part of the Troika and the Troika is putting up new money here, an EIB exemption is less so. The EIB is not putting money into this latest Greece bailout. Indeed, it represents countries like the UK which are quite explicitly removing themselves from any such thing.

Now, admittedly, the European Commission is a member of the Troika, and the European Commission is the executive body of the European Union, and the European Union collectively owns the European Investment Bank. So this decision is, as the lawyers would say, colorable. But if the decision to exempt the ECB from the Greece haircut was ugly, then the decision to exempt the EIB is, at the margin, even uglier. I’m not saying it’s the wrong decision, necessarily. After all, sovereign restructurings necessarily have an ad hoc, make-it-up-as-you-go-along element to them.

Indeed, if the ECB’s magical pixie dust means that there’s substantially more EU support for this deal, then it might well be worth spreading it around a bit. But at the same time, predictability and consistency are important as well. And both of those seem to have gone out the window at this point. I wouldn’t be at all surprised if ISDA’s Determinations Committee just said “enough already” and declared an event of default. Because in recent weeks private-sector bondholders have been treated in an extremely cavalier manner. And those decisions have consequences.


I believe that a number of private creditors are holding back in order to force the CAC and a credit event if the ISDA does not rule in their favor.

What Europe has done is created a bifurcated market for European sovereign debt where public holders will be treated differently than private holders creating two risk profiles depending on who is the buyer.

This will cause European yields to rise in the private market as everyone takes into account this new angle to credit risk.

Honestly, if you have to get this cute in crafting a solution then it is not a viable solution.

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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”

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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

The Greece game turns chaotic

Felix Salmon
Feb 17, 2012 06:18 UTC

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

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

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

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

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

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

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

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

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

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

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

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

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


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

对冲基金 http://www.cnhedge.com
金融百科 http://www.jinrongbaike.com

Posted by cnhedge | Report as abusive

Rubber ducks explain the Greek negotiations

Felix Salmon
Feb 10, 2012 01:40 UTC

Is there really a done deal in Greece? I hope so — but it’s pretty clear that nothing’s in the bag quite yet. In terms of my video above, the Greeks consider themselves in the boat at this point — but the Europeans worry that the Greeks might go back on their promises, so they want not only the Greek executive but also the Greek legislature to sign on. (I didn’t even have a duck for the Greek legislature, I thought the only legislatures we needed to worry about were in Germany and Finland.)

And the IMF duck isn’t in the boat either — Christine Lagarde, too, is demanding further “assurances Greece would stick to the agreed policies whatever the outcome of looming elections”.

It seems that the bondholders are in the boat, however — or as far in the boat as they can credibly get absent a formal bond exchange offer. And that’s why I’m not sold on Floyd Norris’s idea that the money Europe is providing for Greece will instead end up in an escrow account, to be used first to pay bondholders and only second to cover the Greek budget deficit.

If that were the case, the value of the exchange offer would rise markedly: the new bonds would certainly be repaid, and would be worth 100 cents on the dollar, rather than the 60 cents or less that everybody’s expecting right now. It would be a multi-billion-dollar gift to bondholders who expect much less than that, in a context where a few billion dollars could well make the difference between a successful deal and a failed one. If there’s effectively going to be an EU/IMF guarantee of the new Greek bonds, then the nominal haircut would surely be bigger than 50%, and I haven’t heard anything along those lines.

Basically, what’s going on here is that because the bondholders are already in the boat, no one needs to do them any favors. What’s needed is an agreement between Greece and the Troika — something acceptable to both sides, and which the Troika believes that Greece will hold to. Even as sensible people like Mohamed El-Erian can see clearly that that’s not going to happen. “I suspect all three parties to the negotiations know in their heart that their latest agreement, brave as it is, will only last a few months at best,” he writes. “Within a few months, the negotiating parties are likely to be back at the table bickering while Greece continues to stare into the abyss.”

Or, to put it another way, that overloaded pirate ship is very precarious. And even if it manages to get everybody on board now — which is far from certain — it could still easily capsize a few months down the road.


TFF, which is why in a democracy no one ever votes for it….

Posted by Danny_Black | Report as abusive

The ECB starts getting helpful with Greece

Felix Salmon
Feb 7, 2012 23:14 UTC

Stephen Fidler reports that the ECB is kindasorta going to tender its bonds into the Greek debt exchange, thereby helping the country achieve some €11 billion in extra savings.

The details are sketchy, but to a first approximation, it seems to work like this: the ECB has €50 billion of Greek bonds, which it bought for €39 billion. It will sell those bonds to the EFSF for €39 billion, which in turn will “return the bonds to Greece”, whatever that means. Greece, in turn, “will then agree to repay the EFSF” — which may or may not mean issuing new bonds to be held by the EFSF. Since Greece will now have €39 billion of debt rather than €50 billion, that’s an €11 billion savings.

The ECB, under this plan, ends up breaking even, without monetizing any debt. As Zero Hedge says,

The ECB could have taken the loss directly and just printed money for that loss. So this demonstrates an unwillingness to print money. The ECB could take the loss and get capital from the member states. By using the EFSF rather than new capital calls, it is a sign that countries are at the limit of what they will contribute. Hoping for new money is unrealistic – since this was the perfect opportunity to put up new money and tell the world that Europe is truly united and willing to contribute. This just uses up money that was already allocated.

I’m also a bit worried about Greece’s new €39 billion debt to the EFSF — how is that going to be structured? Right now, the €50 billion of ECB debt comprises exactly the same bonds that anybody else can buy, but a big new EFSF debt might well be some kind of senior, bilateral obligation which effectively subordinates the new bonds that Greece is going to issue in a bond exchange.

And more generally, the problem here is that the EFSF, which was created to lend new money to countries in distress, is instead being used to retire debt that Greece issued years ago. That, in turn, hurts the EFSF’s ability to fund Greece — and all the other countries in Europe, for that matter — going forwards.

So there’s not a lot to get excited about here in structural terms. In big-picture terms, however, this is clearly good news, since it’s a signal that Europe is actually finding ways to get everybody on board for a new debt deal between Greece, its bondholders, and the Troika. Will it be enough? No. But it’s a step in the right direction.


(quote) Athens and the commercial banks are urging the European Central Bank to forego profits on its Greek bond holdings to help cut the debt to a sustainable level. (http://www.reuters.com/article/2012/02/ 08/us-greece-idUSTRE8120HI20120208)

thought so, the wsj article was a piece of murdoch-inspired bullsh*t
trying to prime the gun for Athens

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