Wolfgang Munchau On How The Greek Rollover "Deal" Is A Toxic CDO

Tyler Durden's picture

A week ago, Zero Hedge penned "An MLEC In PIIGS' Clothing: The Latest Greek Bailout Proposal Picks Up Where the Super SIV Failed" in which we explained how the current fatally flawed proposal for a Greek bailout is nothing more than a structured vehicle, expected to remain off the books, and much more importantly, expected to not trigger rating agency ire, and kill the entire extend and pretend game: remember - an Event of Default by a rating agency, even a Technical one (completely irrelevant of what ISDA does with Greek CDS) means game over for the European Central Bank and its €2 trillion in "assets", not to mention the western financial system. Now, a week later, the FT's own Wolfgang Munchau explains why our observation of how toxic the "bailout plan" is was rather accurate: "This structure is still not quite so complex as some of the more elaborate CDOs we have encountered in the global financial crisis. If you take some time to work through the arrows and boxes, you see relatively quickly that this complex structure is not a private sector participation at all. Rather it is a private sector bail-out... I have no space for a large drawing with lots of boxes and arrows to explain the complexity of the vehicle, through which eurozone governments want to involve the private-sector banks in its next loan package." Munchau's conclusion: "If this was any other field of human activity, you would go to jail if you accepted, let alone made such an indecent offer." On the other hand, all is fair in love and perpetuating the ponzi Status QuoTM. Our follow-on observation that "The two things that are keeping the Eurozone afloat: an SPV and a CDO" alas appears also to be rather in line. And before the entire financial system collapses upon itself like a cheap lawnchair, this will be fondly remembered as one of the more prudent "rescue" mechanisms enacted to delay the inevitable.

And inevitable it is:

It is also inevitable that Greece will default on its coupon payment at some point. The interest will be 8 per cent under a benign growth scenario, and 5.5 per cent under a not so benign one. Either way, Greece cannot pay such a high level of interest.

Here is how the CDO looks like graphically:

Munchau gives more details:

So here is my best attempt in words: if you own a Greek bond that matures by June 2014, you keep 30 per cent of the redemption as cash, and roll over 70 per cent into a 30-year Greek government bond. The Greeks will have to pay an annual coupon, or interest rate, of between 5.5 per cent and 8 per cent. The precise rate will depend on future economic growth.

Of the money received, Greece will lend on 30 per cent to a special purpose vehicle, another well-known construction from the subprime mortgage crisis. The SPV invests into AAA-rated government or agency bonds, and issues a 30-year zero coupon bond. The purpose of this is to guarantee the principal of the 30-year Greek government bond that you just bought.

With this construction, the downside to your losses is limited. Depending on how some of the parameters of this agreement evolve, you will probably make a small loss, relative to the par value of your holding. If you are lucky, you might come out positive. You will probably not be lucky. But you will still be better off than if you sold today, or if Greece were to default. More important, the accounting rules allow you to pretend that you are not making any losses at all.

The punchline is not surprising, but it is funny:

The rollover agreement represents, from an economic point of view, nothing but a collateralised bond. It subordinates all other bondholders. The rating agencies would normally not hesitate to attach a default rating to Greek government debt.

So the solution is to create a complex structure, and claim that it is technically not a collateralised bond, but something that defies definition.

As for Greece, which as even Juncker now agrees it is game over, they have all the cards in their pocket:

Just why the Greeks would want to accept such a ruinous deal is not clear to me. They did their duty last week when they voted for the austerity programme and its implementation law.

The acceptance of the terms of this private sector participation agreement was never part of the agreement with the European Union and the International Monetary Fund. They could therefore simply refuse, and throw the ball back to Europe’s squabbling finance ministers. I doubt they will do this. They seem scared about the consequences of an immediate default.

Nevertheless, once the treacherous nature of this contraption is fully understood, I would expect the politics of crisis resolution in Greece to become even more difficult, and accident-prone.

The MLEC did not work for Subprime. It will not work here either. But whatever can buy a few days or weeks of no volume levitation for the market while the insiders and smarter hedge funds cash out to the biggest grenade holders will work for the time being. And when that fails, some other insanely idiotic idea will be proposed... and swallowed hook like and sinker by a market which is getting depressingly dumber by the minute, although explainably so: everyone is on the same side of the boat once again.

If anyone dares to point out that the ponzi viceroy of the world is naked, it's all over.

h/t London Dude Trader