Greece – Has The Barber Retired?

Posted by on Dec 2, 2011 in Uncategorized | No Comments

There is a Bloomberg story out there stating that the debt negotiations are “complex”.

We never believed that the PSI “haircut” was going to get done as a voluntary negotiation.  The IIF didn’t have the authority, and having the country take over negotiations has made it even less likely that any haircuts occur without a failure to pay to force the issue.

So long as the TROIKA keeps making the payments, the banks have no reason to reach a settlement, particularly on their shorter dated paper.  €44 billion of Greek bonds come due next year.  How much of that is held by banks or insurance companies that are supposed to negotiate, I don’t know.

In fact, how much debt is even held by banks?  We argued right from the start that banks would shift their “basis” packages to hedge funds or other investors who wouldn’t be subject to the negotiations.  The “basis” package decreased in value from about 100 prior to the PSI announcement, down to just under 90 (bonds at about 27 and CDS at 63).  With CDS at 63 it is not worthless by any stretch of the imagination (The real reason the voluntary haircut is hurting sovereign debt  I suspect that banks have shifted the package off of their books.  Why would banks want to own a bond and get bogged down in the negotiations and have a CDS that might rally depending on the outcome.  By selling them as a pair, they would have lost less than 10 points depending on the timing.  Not good, but meaningful, and safer than getting into a situation where you have to write down your bonds and the CDS rallies on the forgiveness.

So I would guess that banks have fewer bonds on their books than back in October when the plan was announced.  I would also guess that the average maturity of the debt that banks hold has decreased.

So banks are heavily incentivized to draw out the negotiations in hopes that their near term debt gets paid, but even if they agree to a haircut in the end, will it make a difference?  If the banks don’t hold much paper because they have sold the packages, then even if Greece gets an agreement from the banks, it won’t have a material impact on the amount of Greek debt outstanding.  Greece is ultimately going to have to negotiate with investors that the EU and ECB cannot put as much pressure on, because they don’t rely on their direct or indirect support for their daily existence.

Yes, the EU’s own policies forced the bonds out of the hands of owners that could be forced to negotiate, into the hands of true private holders who can run the basis package and are somewhat indifferent to whether they get back par because CDS triggers or because the bonds they hold against CDS mature at par.  Well, actually they do care.  They would rather have a default in most cases, because they would monetize the profit sooner and not have to keep the positions on the books.  So more bonds are now held by investors who would prefer a quick default.

So ultimately, I don’t see a way for Greece to avoid having a failure to pay.  The agreement with the banks doesn’t do enough (especially if they really have sold all of their basis) and there is no way to force a true “for profit”, “not living on government funding” investor to agree take the hit without defaulting.  I am sure someone will argue that these were “unintended” consequences when what they really mean is that these are “unwanted” consequences.  The consequences were quite foreseeable.  It was relatively easy to map out the chain of events that has occurred, and now made the situation more difficult.  It is not what they intended, and it is not what they wanted, but they should have expected the consequences.  Politicians and central bankers have to stop hiding behind the “unintended” consequences phrase when the consequences were quite likely to occur as a direct result of their actions.

With the latest round of IMF money likely, this gets pushed off until sometime next year.  Greece and the EU aren’t ready to contemplate a default while trying to piece together the plans for the other members.  There is no way that they would take that risk until they are comfortable that they have stopped the crisis.  So in the meantime, short dated bonds are likely to get paid par, and this is on the backburner, but just because it is on the backburner, doesn’t make it go away.

Sarkozy made some comments yesterday about how there wouldn’t be another default in the Eurozone other than Greece.  The politicians have to be very careful, as language like that, if it came from the leaders of Greece, might be enough to try to trigger a Repudiation/Moratorium event, which would extend the maturity of near term CDS contracts.  That remains unlikely, but as the rhetoric increases in an effort to cajole banks into agreeing to a plan, they run more risk of saying something that effectively invokes this clause of the CDS contract.

The daily dialogue that some sort of bailout and some sort of solution and some central bank action seems to be churning along, but the Greek haircut will ultimately have to be dealt with and I don’t see how it is accomplished without a failure to pay and involves all bondholders.  Some holders may receive preferential offers (ECB and Greek Institutions) but avoiding an honest to goodness failure to pay seems impossible, and avoiding the writedowns altogether also seems impossible.