cost for a country hits 10% it is just a matter of time before the
wheels come completely off and a restructuring is the next step. I saw
this in Latin America many years ago. For sure, the status quo can be
maintained for a bit, but the inevitable result is that the situation is
unsustainable and not fixable short of a major restructuring of the
country's debt. These are the conditions that brought us the Brady Plan
of the Mid 80’s. The same conditions exist today for the PIGs:
A close up of the Greek 5-year. This bond is screaming for a restructuring.
So what's going to happen next? What might a restructuring of Greek debt look like? Things that are likely to result:
-There will be a range of options for holders of Greek debt.
-Principal forgiveness of at least 30% will be one option. In this case
there would have to be enhancement of both principal and interest on the
new debt. The exchanged bonds would be “money good” but they will still
trade at a discount from other AAAs because they will be “story bonds”
with limited demand and liquidity.
-Another option will be for no principal reduction (Par Swap) but an extension of maturities at a sub market interest rate.
-To have the slightest chance at acceptance and success the Par Swapped restructured obligations MUST
have credit enhancement on the principal of the debt that is exchanged.
The end result will be that either the IMF or the ECB (or some new Euro
guaranty mechanism) will be on the hook for Greece’s future
performance.
Let me make some guesses on how these new instruments would trade.
Assume that one held Greek Debt and was willing to exchange it for a new
20-year obligation. Assume the principal ‘haircut’ is 30%. The new
obligation is credit enhanced so that if Greece fails to pay interest
and/or principal on a timely basis the restructured creditor gets
payment from a Guarantor that is equivalent to a sovereign AAA. The
interest set (floater or fixed) on the new Obligation would be similar
to that of the Sovereign Guarantor (AKA: ECB). The new bond will trade
at a discount to its new par value, but it will trade above 90% of par
(@90 = AAA+80; that should find bids).
This means that if an old Greek bond is exchanged for a new enhanced
Greek bond it is worth a minimum of 63 cents. (.70 * .90). If the new
enhanced bond traded at 95% the equivalent would be ~67% cents.
Now the par swap option. Assume that one is willing to exchange an
existing Greek bond for a new one that has a 20-year maturity and a
fixed coupon of 3%. Assume further that the interest payment will have
no credit enhancement. The payment of interest will continue to be 100%
Greek risk. The payment of principal in 20-years would be guaranteed by
an acceptable Guarantor.
This creates a hybrid security that will trade as the sum of its parts.
The principal portion has a Net Present Value of ~44 (discounted at
4.0%; Germany +75).
The interest portion will also have an NPV value. A fixed Greek
obligation to pay interest at 3% would be discounted by the market by
(my estimate) at 10%. The current value of the discounted interest flows
is ~23.0. The sum of the two (Principal + Interest) is ~67.0.
The approaches I have used to evaluate post-restructured Greek debt are
hybrids of cookie cutters. There is a long road map of what happens when
a country goes bankrupt. I just apply the same rules. The guarantee
feature I use is both undesirable, and necessary. The “solution” that
will soon be forthcoming from the likes of the IMF will incorporate
these features.
If you use my numbers/analysis you come up with a range of future values
for Greek bonds of 63-67% of par. Of course one should not take these
estimate too seriously. I would discount them a bit further to be on the
‘safe’ side. Another 10% over my numbers and you get the mid 50’s as a
level where Greek bonds get interesting.
Guess what? We’re there already.
Am I recommending that one should jump into Greek bonds with both feet at this point? Hardly. I am suggesting that the market blowout in Greek bonds today has created the opportunity and the necessity for a restructuring. I think it will come by the end of the month.
If and when it does come, Greek bonds that are bought around 50% of par
could be a money maker. What concerns me is that as soon as this
restructuring is announced the ‘market’ will push Ireland and Portugal
to the same end.
Those that have been advocating debt destruction as the only possible
endgame of too much debt are about to see their thinking become a
reality. Where the process starts is now clear. Where it will end is
anything but.
Being a farm worker, janitor, dishwasher is the easy in terms of challenge and stress to your head. With welfare and no college debt, they get more from the system then they put in.
A more difficult job would be to overthrow the ruling class in Mexico and actually create jobs for others by building an internationally competitive enterprise from scratch. That's what Americans do. At least they used to.