Greek Writedowns - Let's Do ONE Thing Correctly

Tyler Durden's picture

Via Peter Tchir of TF Market Advisors

It is painfully clear now, that in spite of months of talk, headlines, and propaganda, very few people in the EU worked on any details.  I thought, at the very least, they were working with traders, lawyers, and structurers and somehow were just getting the wrong answers.  But now, it looks like asides from the IMF, no one else was figuring out anything, they were just saying what they thought the market wanted them to say.

IMF States that Greek Bonds Need to be Written down by at least 50%

The TROIKA report, released on Friday was horrific.  The situation in Greece was worse than anyone realized, again.  The base case no longer puts Greece on a path to self-sufficiency, and the more dire cases, show it is beyond hopeless.  The conclusion, which the ECB is still trying to fight, is that Greece requires write-downs of at least 50% of its existing private sector debt to have a chance.  Even that level of write-downs doesn’t put Greece on a path to prosperity, but at least gives it a chance.   Germany, and other countries seem to agree with this assessment.  So, if they  want a 50% write-down of Greek debt, let’s do it right.

The IIF should not be part of the write-down, they are glorified lobbyists who have lied from the start

Many argue that the lobbyists already have too much influence on public policy, but at least we still go through the motions of having the governments write the policy.  The “Global Association of Financial Institutions” has the interests of their members at heart.  They want to do as little as possible and receive the most benefit from doing so.  They are not doing this for the “public” good, or what is best for sovereigns, they are doing this for what is best for “banks, globally active securities firms, and insurance companies.”  All anyone has to do, is look at their July “21% haircut” proposal for a few minutes, and you can see that it is contrived to actually benefit the banks while sounding like it helps Greece.

The “21% Haircut” Proposal was a gift to banks, not from banks

The IIF plan had 4 options, but 2 were essentially the same, and show most clearly the games the IIF was playing.  Banks could exchange existing Greek bonds for new Structured AAA Greek Bonds (“SAG”).  The old Greek bonds would be exchange for an identical par amount of SAG bonds. The SAG bonds would have their principal protected by an EFSF zero coupon bond (the time of the proposal, the EFSF was only going to issue €440 billion and was certainly going to be AAA, as opposed to the Aa3/AA- we now see it receiving). An aggressive bank could do this switch without taking a write-down.  The bank would argue that the principal amount hasn’t changed and the new note actually has the principal amount protected by a much higher rated entity, so they could do a par/par exchange and not have any accounting impact.  It may seem bizarre, but most of the bank accounting rules focus on risk of principal and not risk of interest being received.  The SAG and the entire IIF proposal was designed so that banks could try and swap out of old Greek debt for new Structured bonds without an accounting impact.  Good for individual banks, but bad for the financial system as a whole.

The banks would be taking bonds worth about 40% of par, but marked at 100% of par, and would exchange them for new bonds, which they would also mark at par.  No accounting write-down for the banks, but maybe there is a real economic write-down?

There is no Greek bond with over 9 months to maturity trading about 45% of par.  Only a third of Greek debt has a coupon above 4.75% (and the 3 bonds with the highest coupons were issued in 1998, 1999, and 2000 where somehow 6.5% coupons were fine).

So, the IIF was going to “force” banks to exchange bonds where all of the exposure was to Greece and are trading at less than 45% of par, and make them take bonds where on day 1 they received a zero coupon AAA bond worth 35% of par, and received (in most cases) higher coupons than on their existing holdings?  Yes, they did have to extend the maturity, but the SAG bonds put them in a much better risk position than the old normal Greek bonds.  The value of the AAA zero is critical.  If banks sold their Greek bonds in the market, they could barely afford to buy the zero, let alone have money left over to get a stream of income from Greece.  In the exchange, they were basically getting the Greek flows for “free.”   In fact, under any stressed scenario where Greece defaults, the banks that did the exchange were better off.  Under any scenario where Greece survives and makes payments, most banks also do better as the coupon from SAG is higher than what they were earning directly.  Scenarios where Greece would have made it to the maturity date of your holding and then defaulted are worse, but that is an exceptional case.  The reality is that the banks dramatically increased their downside protection, and in most cases actually got some upside from the exchange.

So where did the 21% haircut everyone writes about come from?

The exchange gives the banks the ability to avoid recognizing an accounting loss, gives them higher recoveries in event of future default, and increases the current income for most banks, so clearly I’m missing something as EVERYONE KNOWS that the IIF plan was a 21% haircut?

The 21% number comes from the IIF discounting the EFSF zero at a certain rate, and the Greek coupon flows at another rate and showing that the combined NPV of the SAG bond is 79%.  It is as simple as that.  They run a calculation that determines the SAG bond is worth 79% and voila – the banks are taking a 21% haircut.  But couldn’t you have run the NPV calculation using other yields and got a different answer?  Yes.  Doesn’t it seem that exchanging an asset with a market value of 40% into something with an NPV of 79% is considered a haircut?  Yes.

What about residual bonds that don’t get exchanged?  This is a real Problem

This is the real problem with a voluntary exchange.  What bonds are covered?  Are the bonds held by the Greek pension system covered?  If not, then you can see why banks would be reluctant to do anything that changes their status when one of the biggest holders isn’t affected.  What about bonds held by hedge funds?  And yes, believe it or not, hedge funds do own Greek bonds at these prices.  Those bonds would not be affected by any voluntary exchange.  Even IIF members were only asked to do 90% of their bonds.  In the end, there will be SAG bonds and residual Greek bonds.  These residual Greek bonds create a lot of potential problems and conflicts of interest that not only are not being discussed, I now firmly believe, haven’t even been thought about.

Once the “voluntary exchange is done” what will happen to these residual bonds as they mature?  Will Greece pay them back at par?  If Greece is willing to pay them back at par, they will be rewarding those institutions outside of the IIF control (hedge funds in particular).  It will also encourage the IIF members to exchange as few bonds as possible and to hold on to the shortest dated bonds in hopes that Greece will pay them in full.  The deeper the “haircut” is (and the more real it is), the more IIF members have an incentive to find loopholes and keep as many residual bonds as possible.  It is a weird system, where bonds that don’t “participate” are treated in a better fashion than those that do.  In a typical corporate “pre-packaged” bankruptcy filing, there is an incentive to participate.  Those bond holders who don’t participate, typically get less by waiting and fighting in the courts.  This Greek exchange plan creates the opposite incentive, you are encouraged to avoid participating, as you will likely receive a higher payout later.

Couldn’t Greece default later to punish those who didn’t participate?  Yes, they could, but so far the EU and everyone else has shown such an aversion to triggering a CDS Credit Event that they seem unlikely to default in the future.  Their (irrational) fear of triggering a CDS Credit Event makes the problem of what to do with residual bonds, that much greater.  Creating two classes of bonds is not a good solution, particularly when the methodology for creating the two classes is so subjective.

The wonderful world of CDS

Have the “authorities” asked the banks for all of their CDS trades. The regulators or EU by now must know who has net exposure to CDS and where the counterparty risk lies?  It would seem to be a no brainer to have collected the data and know with certainty, who has what position, at least for regulated entities.  Although it is a no brainer to me, I wonder if they have done this?

I have written about CDS and the benefits of triggering it before, so I will only mention them briefly.  Banks that hold Greek debt and are being forced to take “voluntary write-downs” who bought CDS to hedge themselves are being punished.  They are being taught a lesson that hedges, at least in regards to sovereign debt, are a bad idea.  This is a big problem going forward that the EU is creating as it shows banks that managing risk through hedges is extremely risky when they can change the rules at any time.  It is also ironic that the “basis trade” of owning bonds and being short CDS would work for hedge funds since they don’t have to agree to anything on their bonds if it is “voluntary” and run through the IIF.  Even more perverse, it encourages the “dumb” banks, that selling protection (getting long credit via CDS) is better than buying bonds.  A bank that bought €100 million of bonds, will be worse off than a bank that wrote $100 million of credit default swap protection?  An ironic and frankly stupid outcome of this fear of CDS.  The EU should be encouraging bond purchases, not leveraged CDS risk taking.

All DTCC evidence (which covers everything except some legacy trades and structured trades) shows that the Net exposure on Greek CDS is less than 1% of the bonds outstanding, and that across all sovereigns the Dealers (big banks) are net short credit via CDS.  In fact across all sovereigns the DTCC data shows that dealers have bought $21 billion of credit protection, so are in fact net short.  This fits the line that many bank CEO’s state they have minimal net exposure as they have bought hedges.

It is time for a real default

The IMF and other countries finally realize real losses need to be taken and recognized on Greek debt.  For once, they can step back, break away from their existing thinking – the IIF’s PSI proposal – and do something that will actually work.

Greece needs to say it is not paying back debt and stop paying back debt.  It should offer to exchange old bonds for a series of maturity staggered new bonds, with an exchange rate of 40% of par.  After the exchange period, Greece should not pay any of the residual bonds and fight tooth and nail to give the lowest possible recovery – zero.

This will ensure that all bonds are covered.  You do not want two classes of bonds, and you do not want the option in the hands of the bondholders, it has to be controlled by the issuer.  The likelihood of getting a higher recovery in the future by not accepting the initial exchange, has to be low (and it should be since the reality is sovereign debt holders have very few rights in the event of default).

The CDS will trigger and in the end payments will be made and there will be no calamity directly from the CDS market.  If there is any calamity, it will come from those who hold bonds and were not prepared.  If the market can handle a CDS Credit Event on Greece, and I think it will, that would be a big positive for the market.  It also means that banks don’t have to sell other PIIGS debt because they know their hedges are good.  Avoiding a CDS Credit Event leaves question marks, and hopefully after 18 months of this, the EU and IMF are finally realizing that closure can be better than kicking the can.

A real default is the only good and fair way to ensure the write-downs occur and the system can move beyond Greece.  Realizing that the problems in Ireland and Portugal and Italy and Spain are similar to but not correlated with Greece, may also help.

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Manthong's picture

write down Greece 50%??

OK.. but how can you do that without triggering real, card carrying  technical default?

(ha ha.. only by lying)

DormRoom's picture

'Song for the Unification of Europe'


composed by Zbigniew Preisner and sung in Greek

traderjoe's picture

Why do sovereign countries borrow at all? Default on the private cartel currency and simply create new interest free debt free script. See the united states note.

ratso's picture

Greece has done the same thing only with other Europeans money - and, now those Europeans don't like it.

The easiest solution that could have been acted on in the beginning for all the Greek debt was to have the ECB, EFSF and EU buy it ALL from the banks.  That will look like it would have been a bargain in the next few months now that they didn't have the courage and foresight to have have done it.  There would have never been additional payments to Greece and the Greeks would have been free to fend for themselves without oversight and without an ability to borrow.

topcallingtroll's picture


When short term debt comes due or matures, the creditors "volunteer" to roll over the money into new long term debt with a NPV of fifty percent of what the original short term debt would have been worth at maturity.

So you dont get your money back when your two year greek bond matures. You get a thirty year bond instead, and its current value is only fifty percent of what you should have received in cash when you redeemed your original two year bond. That is a fifty percent haircut, but you volunteered to give away half your money, so no credit event.

Just jigger the interest rate and maturity and you can turn a voluntary rollover into any size hair cut you want, in terms of net present value.

taraxias's picture

What you described is defined as a "credit event" (default). Funny thing is it appears you don't even know it.

Easy my ass.

topcallingtroll's picture

Read more carefully.

It is not a credit event if all the european banks "voluntarily" roll over their short term debt into long term debt.

"Voluntary" rollovers are not credit events.

Everybodys All American's picture

What this points out is that the whole CDS as insurance against default(s) is complete and utter BS. Because we all know how voluntary this is likely to be and no one can or will pay on the default, fake default, voluntary default or whatever you want to call it.

Everyman's picture

Scissors, Bitchez!

SWRichmond's picture

Yes, now that the US banks have moved their swaps onto their depositors' books, by all means let's start the fun!


Long PMs, bitches.

oogs66's picture

yeah, they can't put them on an exchange, because that would be far too complicated, but move them to a safer entity for their counterparties, that can be done in a day :(

Tucson Tom's picture

OK,I get this,but if you are sitting on mostly cash,Where do you go with it? I moved out of B of A,six months ago.What if you have 6 figures in cash in Schwab? Where does Schwab keep their cash? Gets sticky unless you keep it under the mattress.Ideas please!

Hulk's picture

Gold, the physical stuff...

topcallingtroll's picture

Long term money dollar cost average into EWZ.

for your short term stash a combination of money markets in various currencies and some gold ought to keep you fairly stable.

buzzsaw99's picture

They could force a haircut on some bond holders way greater than 50% by just buying Greek debt on the open market. They are so inept it is hilarious.

oogs66's picture

wrong, the worst banks won't sell, so all the open market purchases do is let the dealers make some bid/offer...the dumb banks will hold this til par or death

ArkansasAngie's picture

Repeat after me ... this is a solvency issue and not a liquidity.

Hold'em to maturity ... if you can

And to think people are furious with governmant.

Maybe it's because the government is listening to the whispers in their ears and not the roar outside the gates.


The4thStooge's picture

This remineds me of a saying I once heard regarding large women and musical performances...

buzzsaw99's picture

to so arrogantly say that I am flat wrong is to say that **ZERO** Greek bonds are available at market prices. I say that you are full of crap and should thus STFU about it.

ZeroPower's picture

Wrong. While some GGBs might be trading on any given day, it merely facilitates dealers in catching their b/o for the day, i.e. HF calls in wanting some exposure to Greece as a lottery ticket. Or to show some sign of activity in an updated px available on the market - even though you might see an offer of 45 flash on your screen, you'd be very hard pressed to find any size in either buying or selling amount.

The big funds (read: long only) who are otherwise not allowed to hedge their long bond exposure (by way of short credit) are sitting tight no matter if the bonds trade to either 10 or 90 tomorrow. 

High Plains Drifter's picture

All DTCC evidence (which covers everything except some legacy trades and structured trades) shows that the Net exposure on Greek CDS is less than 1% of the bonds outstanding, and that across all sovereigns the Dealers (big banks) are net short credit via CDS. In fact across all sovereigns the DTCC data shows that dealers have bought $21 billion of credit protection, so are in fact net short. This fits the line that many bank CEO’s state they have minimal net exposure as they have bought hedges.<<<<<<<

somehow i just don't believe this.

Mike2756's picture

Who would they have bought protection from?

oogs66's picture

hedge funds?  dumb banks that should go under?  who knows, but in any case it is amazing that something as important as this, that occupies so much time for regulators and politicians ISN'T EXCHANGE TRADED!!!   How can this product not be properly controlled yet??????

High Plains Drifter's picture

that i would like to know.  also would a greek default be like the first domino to fall.   obviously there are things going on, (of course) that we don't know about.  otherwise they would have allowed a default a long time ago but some of the big players don't want to get stuck with the bad paper and as reggie wrote about , they are wanting someone else( you know who) to pick up the tab for their failed usual.  it is time to fix bayonets and do some pig sticking.....

topcallingtroll's picture

Why who do the big players want to take money from? Who could possibly make up their losses so they can stay rich?

You are not thinking taxpayers are stupid enough to give rich people money when their investments go bad.

Surely not!

DeadFred's picture

"Their (irrational) fear of triggering a CDS Credit Event makes the problem of what to do with residual bonds, that much greater."

It may not be such an irrational fear. Maybe they understand the credit event will be the TNT charge that sets off the fission explosion that sets off the fusion bomb. Context is everything with these events.

oogs66's picture

or maybe like everything else, they got that idea in their head and haven't once tried to see if it is correct?

Chief KnocAHoma's picture

When you're ready to bug out of Europe:
bigwavedave's picture

Yeah Fuck the banks. Greece needs to default AFTER getting as much bailout as they can squeeze. Will go there on holiday next year and spend some Drachma. Its how it should be.

topcallingtroll's picture

You should be able to buy some greek college girls cheap after the reset.

I bet they go for ten percent of a high end, low volume escort (the safest) compared to the USA.

A $1000 per night bombshell twenty something escort will go for the equivalent of 100 usa dollars when converted to drachmas.

ArkansasAngie's picture

I'm sorry ... but all this accounting machinations is getting really, really old.

Can you people not think in terms of real numbers and delete all this imaginary crap.

The fact of the matter you guys placed your bets and lost.  Now pay up shatheads.

We need to be occupying the DOJ and the dad gum FBI.

GAAP has meaning to us peon.

You want instruments?  I'll show you instruments.  Try a pitchfork up your arse


High Plains Drifter's picture

pitchforks are cool.  they make 4 small perforations in the stomachs of bankers when applied correctly...

DeadFred's picture

And like the Greek bond problems the wounds are not that impressive to look at, but completely lethal.

topcallingtroll's picture

Arkansasangie I am already in love with you.

I live in fort smith.

Petite beorgeoise lifestyle.
Dr. by trade.
Libertarian at heart.

That turns me on that you probably know what GAAP stands for.

ArkansasAngie's picture

Are you good with going to an occassional Razorback game?


TheSilverJournal's picture

All of the Euro leaders are depending on the bank lobbyists to figure out how to maintain the Euro. 

BandGap's picture

Then they aren't really "leaders", are they?  Let the blame game begin.  Who left the henhouse gate open for the fox to get in?

Bithead1's picture

Greek Groupon?


maxw3st's picture

I think you hit on something there. And, it would certainly help with Groupon's flagging IPO.

Hansel's picture

Any word on the proposed haircuts for Ireland and Portugal?  This won't be over for a long time.

BandGap's picture

No, it will be over....suddenly and quite brutal.

Wonder how many will realize when they go off the cliff?

Hey, Baracka needs my help.  Fancy that.

spanish inquisition's picture

Ah yes, the Irish politicians who bent over for the price of a happy meal, now see the Greeks and how much they could of charged if they would of played hard to get. Of course Portugal could still toss bankers in jail, using the Iceland approach and still have its virtue intact.

BandGap's picture

Somebody put on a fresh pot, we'll roll up our sleeves and clean up this mess.  I have seen 50% off sales before, and this close to the holidays things are going to get hectic.

lolmao500's picture

Let Greece get out of the euro. (still won't solve the problems, but still)

Will be interesting to watch when we reach the point that Italian bonds and FRENCH bonds have to take a 50% cut... But I doubt the EU will make it that far.

Banksters's picture

So this means I should be buying Italian bond with both hands.   Shit, I don't have much money though because I spent it all on the Mexican 100 year bond!   Fortunately they are liquid, like piss...

BandGap's picture

Get them while they're hot!

The funny thing is they have no idea where and at what point they can stop the snow boulder from crashing into Chalet Europe.  But the longer it rolls, the bigger it gets.