Guest Post: Greece - Is The Shotgun Wedding Still On?

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From Peter Tchir of TF Market Advisors

Greece - Is the shotgun wedding still on?

Last week I used the analogy of a shotgun wedding to describe how the bailout was being forced upon the Greek people.  Maybe, after the events of this weekend, I wasn’t being harsh enough in my choice of analogy.

As I continue to digest the news and various opinions, I still reach the same conclusion.  Default or restructuring is the most logical outcome and should occur sooner than later.  I believe that the image of the IMF has been tainted and it will make it more difficult for the Greek people to accept a deal from them, unless the terms are incredibly favorable.  I’ve also listed several of the arguments most commonly used to encourage Greece to delay restructuring, and point out the flaws in each of them. 

Greece will be more reluctant to do the bidding of the IMF

It seems like the experts are split on whether the IMF will continue to aggressively pursue existing policies (bailout after bailout) or whether the IMF may pull back a bit and encourage some form of restructuring.  I don’t have a strong opinion on how the political maneuvering will play out, but I am certain that the Greek people are even more strongly opposed to the IMF than before.  Regardless of how the case against DSK plays out, the indelible image of a corrupt, power hungry, arrogant man, preaching austerity while sipping champagne in first class, has now been firmly burned into the mind of every Greek citizen.  A population that has already been resistant to harsh austerity measures, is going to be even more determined to fight anything they view as an IMF directive.  This will make it harder for Greek politicians to agree to any unfavorable terms for further IMF assistance.

Uncertainty is no reason to waste money paying creditors

Over and over, people bring up the uncertainty and weakness of the Greek economy as a reason to delay restructuring.  It is widely agreed that Greece cannot afford to continue to make payments at current levels.  Some people argue that Greece should continue servicing debt until it becomes more clear what it can afford on a long term basis.  Some argue that even without paying interest, Greece is still running a budget deficit.  Both of those arguments seem to be self serving arguments defending existing bondholders.  The harsh reality is that Greece cannot sustain current debt payment levels, so they should stop those now while determining what is sustainable.  Every euro paid out now to bondholders is a euro less that is available for the future.  Spending more money they don’t have in the interim is not in any way helpful in developing a long term solution.

Greece won’t be able to borrow to meet short term needs if they default

BS.  That really is just wrong.  The capital markets still have excess cash for credit worth lenders.  If Greece defaults now, prior to creating a senior class of government lenders, or pledging collateral to those lenders, Greece would have plenty of options to create debt that the likes of Blackrock or Pimco would scoop up.  Rather than wasting their ability to collateralize debt or create a senior block of lenders in a futile effort to delay eventual default, they should default now and use those resources to secure new loans as part of a sustainable long term budget plan.

The Greek Pension Funds will be hurt

Yes.  Greek pension plans own a sizeable amount of Greek debt.  The losses will hurt.  Well, maybe that will help force the people to accept reduced benefits.  As part of any long term solution, benefits will have to be cut.  It is painful.  People are very reluctant.  As distressing as it might be, a combination of actually seeing the losses and witnessing defiance against all lenders, the people might be more willing to accept the reality of cuts.  Actual losses will make it more clear that there is no choice.  ‘Stuffing’ the foreign lenders may help the Greek’s see this as shared pain rather than just more austerity to save lenders.

Greek Banks will fail

Many, if not all, Greek banks will fail.  Having to realize the loss could cause them to fail.  If they were on a mark to market accounting basis, they probably would already have failed.  If book value accounting is actually working to keep the banks alive, then the restructuring should be able to use a brady bond style solution so that the banks don’t have to take the write downs.  But there is a better solution.  Rather than paying interest on all of its obligations, in an effort, in part, to save these banks, why default.  With the full interest payments saved, the Greek government can come in post default and allocate money to the banks that are savable.  With some direct equity investments, post default, the Greek government will have used far less cash, have more control over the banking system, and reap the rewards if Greece’s new plan works well.  This isn’t good for the senior people at the banks (likely the same ones advising the government) but seems to be the most efficient use of funds for the Greek people.

Greek Citizens will lose money on Greek Bond Holdings

Offer Greek citizens par on some amount of bonds they own.  Sure, foreign lenders will be annoyed, but it isn’t much different than when the U.S. stepped up and increased FDIC limits, and the reality is that the amount of debt that would be affected is negligible.

The Greek Economy will grind to a standstill if they default.

Why?  I’ve seen no evidence that supports this.  Will there be some confusion and some problems?  Probably, but Iceland most recently went through a bankruptcy with minimal interruption.  Argentina defaulted early this century and was not pushed back into the dark ages.   The common currency may complicate the issue, but not defaulting in order to avoid some hysterical claims is illogical. 

Letting Greece go will create a domino effect

This is probably true.  A Greek default will make it harder to save Ireland and Portugal in particular.  On the other hand, even letting Greece struggle along for awhile longer doesn’t ensure that Ireland and Portugal can be saved.  They both have their own sets of problems and may not make it even if Greece restructuring is pushed off.  So finding a Greek solution makes it less likely that Ireland or Portugal would restructure but it does not guarantee that we won’t see other dominos fall anyways.

I found it very interesting that Ireland is already demanding that they get better terms.  It seems that Ireland would have been better off waiting until Greece was ‘resolved’ before raising their hand for more.  In many ways it is harder for the other European governments to give into Greece and Ireland at the same time.  Maybe Ireland doesn’t want to be saved?  The current government was voted in as a direct result of the bailout policies of the prior government.  Maybe they are attempting to derail the Greek bailout so that they too can restructure but without taking the European political blame of being the first country to default?  It is a little far-fetched, but fits the facts.

Where has all the CDS gone?

The CDS market continues to remain a wildcard in this game.  Last year the CDS speculators were blamed by the governments for the problems in Greece.  I strongly suspect that CDS positioning has redistributed the risk in ways that make the worst case scenarios for banks less bad.  At this stage, no ‘dumb’ bank should be long non mark to market Greek bonds and long via CDS.  Any bank that is found to have that position should attract some unwanted regulatory attention.  At these prices/spreads, I don’t think many hedge funds will be outright short.  A lot of the potential gains from a restructuring are already priced in and the carry is costly so it’s just not a great position.  In fact, given all the European government attempts at finding a resolution, many hedge funds are likely long Greece, both in cash and synthetically.  A lot of investors got comfortable getting long Lehman bonds immediately ahead of their bankruptcy, based on the logic that first Countrywide, and then Bear Stearns were saved, so Lehman would be saved too.  A few very smart funds made a lot of money buying short dated Bear Stearns bonds ahead the weekend that JPM saved them.  A lot of funds tried to mimic that trade going into the Lehman weekend.  It didn’t work out so well that time.  This situation is starting to feel the same.  Too many people are relying on the fact that the Greek government has been bailed out before to assume they will be bailed out again. 

Throughout this report, I use the term restructuring somewhat loosely to include the ‘hard’, ‘soft’, and ‘reprofiling’ versions and assume that they will all trigger sovereign CDS.  The governments may attempt to play around with any restructuring in such a way to avoid triggering Greek CDS, but that would be a mistake, especially if I’m correct and the synthetic long positions are now primarily outside of the banking industry the governments are trying to protect.