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The Real Reason The "Voluntary" Greek Haircut Is Hurting
From Peter Tchir of TF Market Advisors
Suddenly, everyone is discussing how the IIF “deal” made sovereign CDS worthless and that is why we are seeing a renewed sell-off in sovereign debt. That is just plain wrong. What the Greek “deal” did was make it perfectly clear, that banks that survive on the benevolence of the ECB directly and the IMF/EFSF bailing out their positions indirectly, will do what the governments tell them to do. The separation of banking and state has been violated. That is the problem, and that means banks need to reduce positions because they are scared of what their masters will demand of them, and they cannot survive a haircut on Italian or Spanish bond holdings.
CDS – Far From Worthless
So many comments about how sovereign CDS is now “worthless” after the Grand Plan and the “voluntary” Greek haircut. Greek CDS closed at 61.5 on October 26th. The Greek 5 year bond closed that day at 38, making the “basis package” price of 99.5 (you could buy the bond at 38 and CDS at 61.5). By the close of business on the “legendary” day of October 27th, the CDS had closed at 54.5 and the bonds at 41.75. So both the bonds and CDS improved on hopes the “Grand Plan” would work. The basis package was at 96.25 because CDS outperformed. That made sense as banks in particular would want to sell their CDS since it wasn’t going to be triggered. Some would also sell their bonds (ie, the basis package) because they wouldn’t want to deal with the negotiations – because frankly who really cared about the IIF until this “Private Sector Initiative” was announced. Other banks may have sold CDS but held onto their bonds because an NPV of 50% is higher than where they had the bonds marked.
As more concern grew about the “voluntary” nature of the “proposed NPV haircut grew, the CDS continued to squeeze tighter and was at 51.5 by the end of the next day, while the bonds stagnated and closed at 42, making the “basis package” worth only 93.5. This, it turns out, was the best it got for sovereign credit. Those same Greek bonds now trade at 29, and the CDS is back to 61.5. So the basis package is down to 90.5, but the overall situation is worse.
So to say that “CDS is worthless” you would need to argue that a price of 61.5 prior to the “Grand Plan” being announced is worth a lot more than the 61.5 that it is currently worth. Just to be truly annoying, since the CDS trades in $’s, if you convert the price into Euro’s the value has INCREASED, since October 26th, as the Euro has dropped.
It isn’t just Greek CDS that experienced this “strange” form of worthlessness. Italian CDS went from 457 prior to the “Grand Plan” to 400 by the end of the first day’s rally based on an overly optimistic assessment of the plan’s potential. It got as wide as 595, and is only back to 540, after serious ECB intervention in the bond market. So it is more than 80 bps wider since prior to the “Grand Plan.” The story is almost identical for Spain, which went from 380, down to 316, hit a high of 480 and is now lingering at 465.
If CDS Isn’t Worthless, than why are bonds moving wider?
It is clear that CDS isn’t worthless. It is also clear that banks in Europe are not independent of their regulators or politicians. Many of the European banks only survive in their current state because of the backstop provided by the ECB. Without the ECB’s lending, many European banks (in Greece and Portugal in particular) would have to be shut down. Many others would have to shrink dramatically. Without the ECB and FED, many of the “Yankee banks” would have to shut virtually all of their US operations. It is not just the explicit lending that is keeping their businesses intact, but also the implicit floor that gives some brave (or foolhardy) lenders the willingness to lend to them in dollars. On a side note, it seems that more of the Yankee bank funding in the US is coming from money market funds and ETF’s. The banks seem to be smart enough to cut off lending, but the average saver is unwittingly stepping in. That is very similar to Lehman, where banks pulled out, and hedge funds bought the low priced longer dated paper, and money markets and funds, bought the short end to offer “incremental” yield, for a large increase in risk.
Asides from the ECB support which is direct, the banks are relying on the IMF and EU support indirectly. Since over 50% of Greek bailout money goes to service debt held outside of Greece, the real chain of bailout money is from the EFSF/EU/IMF to Greece to EU banks. The banks have been enjoying these benefits. They are quite happy to discuss the situation while in box seats at some Barca match, hoping to get an invite to a private party with Messi organized by some investment bank. They have been busy convincing the various agencies how critical it is to the economy (and not just banks) that these bailouts occur. Most of the talk about austerity seems to be done in plush offices (the IMF offices and meeting rooms that I saw on 60 minutes yesterday seemed off the charts for an agency that lives on public money and shouldn’t have to try and impress people to get their job done).
One little part of the “Grand Plan” was for the EFSF to provide equity capital for banks. It was assumed that it would come cheaply. This was an additional source of leverage the EU had over their banks.
For the first time, banks were threatened by the very agencies and groups that have been propping them up. What could they do? Well, they sent the IIF to the summit as a show of good faith. I don’t think many banks are influenced by the IIF, but it made it look like they were trying something. I believe the banks were more shocked than the rest of us when the IIF “agreed” to a 50% haircut. This was the first time that enjoying the policies of the EU and IMF and ECB had cost them anything. Suddenly all the bailout money, direct and indirect had a cost – agreeing to participate in the bailout in a material way.
Banks are selling because they own too much sovereign debt. Many of the banks own that debt at par. They owned the debt with the conviction that it would eventually be paid back at par. Most assumed it would be paid back at par on the originally scheduled maturity date, but figured, even if the maturities were extended, they could finance the positions for almost free with the ECB and not be hurt too badly. Now they couldn’t hide behind that view. It was clear to all that they might not get paid par for the bonds they held, and even worse, the decision might be taken out of their hands.
We have started to see banks take charges on their Greek debt because of this. They could no longer hope and pretend it was money good. What is interesting is that in spite of these large write-offs of Greek debt, not a single bank has gone bankrupt! What happened to all the people in 2010 said that a Greek default and losses on Greek debt would destroy the banking system? Most banks, as I have argued all along, were actually well enough capitalized to handle a Greek default. All this time and energy and money that has been wasted in the past year to avoid a “calamitous” default was likely unnecessary since the financial system could actually have handled a Greek default. In fact, not only was it unnecessary, it was downright harmful. It took focus off of Spain and Italy who chose to fix nothing. It made Sarkozy say so many cavalier things about bailouts and French willingness to throw money away that it has impacted their spread to bunds. His statements and actions are having a real direct cost to the citizens of France.
So by playing a game with Greece, which they have ultimately lost, they let Spain and Italy slip through the cracks, and let the bailouts spread contagion rather than stop it. They also have looked so poorly advised on things like EFSF that their credibility is dropping.
It is EU/IMF/ECB Intervention in otherwise functioning markets that is making the sovereign debt crisis work
Banks don’t have that many hedges on. Where they do, it is part of a “basis package”. Well over a month ago, we were warning that the basis would shift against holders, not only because of the IIF proposals, but also because of potential direct intervention in the CDS market. We warned that the intervention in the CDS market would only shift the basis and not affect the value of bonds, because the bond markets are bigger and actually drive CDS more than the other way around. Banks will be exiting basis packages (if they are smart), but hedge funds will buy them since they cannot be “voluntarily forced” into accepting any EU plan. In the end, that is somewhat risk neutral and doesn’t explain the big sell off in sovereign debt. What explains the big sell off in sovereign debt is the realization that you may not receive par, and as a member of the IIF, you may be asked by your government to do things you otherwise wouldn’t have done, and given all their support, you would have to do it. The control the EU chose to impose on the banks is why we were selling off, and let’s be totally honest, banking stocks would not have been as high as they got in Europe without all the support from the EU, so it isn’t unfair, it just seems that way.
Making the Greek plan (if it ever gets done) a Credit Event won’t help and would probably make things worse
First, I doubt that the IIF deal will ever be completed. They were never planning on a 50% reduction in notional that Greece owed. They were planning on a 50% NPV reduction in their holdings including some shift of risk from Greece to the EFSF. The plan was always vague at best, and the IIF is a fairly powerless organization. I doubt the plan will come through, but let’s say it does.
Would making it a Credit Event help other sovereign debt? The first problem is that making it a Credit Event would violate the ISDA terms and conditions. As I have written, any entity that decides (for whatever reason) to renegotiate their bonds or loans, should not have the right to trigger a Credit Event. Both the intention of the ISDA documentation, and how it is actually drafted support that conclusion. So without a true failure to pay, trying to make this into a Credit Event when the documentation is clear that it isn’t (and shouldn’t be) would create a new set of problems. Asides from the lawsuits, it would be another example of the EU trying to break the law. It is a very bad idea to force the ISDA Credit Event Determination Committee to call something a Credit Event, when it isn’t.
There would also be some initial fear of cascading counterparty risk. I think the market would be pleasantly surprised to see the CDS settle. There will be growing concern about the health of banks that wrote a lot of CDS and that may translate into margin (collateral) calls, that could be the undoing of some weaker banks. It is what I think makes the most sense, and in the long run is best, but I don’t think it will spark an immediate rally in other sovereign debt.
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"The separation of banking and state has been violated."
Is it just me, or was I the only person who peed myself laughing when I read this...
"I'm shocked to find there is gambling going on in here!"
It all comes down to derivatives.
But I'm drunk. So what the fuck do I know.
I'm going to bed.
Good night, ladies.
http://fucklloydblankfein.blogspot.com
You were not the only person. In fact, after reading that, I just skimmed the rest; no reason to invest time reading when you know the information is based upon ignorance or dishonesty.
I read it. 'Most banks, as I have argued all along, were actually well enough capitalized to handle a Greek default. ' - What?
It was this that did me in. Fractional reserve banking begets insolvency. How he can say banks are well capitalised is beyond me.
They all go bust eventually.
Rule #1 The banks run the government, not the other way around.
Rule # 0 : There are no rules. There is only context.
And that is a superb analysis. So, perception management is speeding the sovereign crisis to it's climax. How interesting. The herd is being herded.
ORI
final-cut-trailer-01/
You got that right ORI. Many waking up to find the context of their situation is all wrong.
As to the article, I think it is more acurate to say that governments do what the banks tell them. This person is delusional, it might be the other way around IF the governments (in particular the U.S. government) were not paying the Fed interest to print money for them. Back to basics. Time to by another dip PMs.
Author needs a good compass or hand-held GPS. He has it all turned around backwards.
I disagree Deadfred, always have. It is the Govt that creates and runs deficits through socialist welfare policies. Deficits must be funded and the banks buy govt debt. The govt looks after banks, but it is still the govt that is responsible for this mess. The banks are just scything off as much cash as they can whilst the going is good.
As far as I am aware this is no different to pre Weimar Germany...
This, except "socialist welfare policies" gives a lower rung impression... it's all about the MIC and top rung welfare queens. Everyone gets their cut for being a middle man, some just get more than others. The wellspring is the desire of the government, not the ability of the banks (granted by the government). Most people have this relationship with the cause and effect backwards.
Not sure what you're saying here but I think we are in agreement. If you're saying that welfare goes up to the top and is an industry in itself I will agree with that. Any job created to reduce unemployment is welfare; I don't want to pay for it but govts offer it and pay for it with debt. Banks buy debt. That's it...
Yes, I was commending you on actually getting the relationship right...
Rapidly losing all respect for this guy. CDS are worthless, Peter. That of course doesn't preclude a bunch of complete fucking morons from buying them...remember way back when how that firm, what was it--man something?--bought up all those worthless Italian bonds..? Yeah. How'd that work out? Peter Tchir, groping through the stygian dark cave of the global financial markets with breadcrumbs and glowsticks.
Take a look at the members who make up the ISDA. These banks are virtually the same ones that hold the majority of CDS. There is no way the committee member(s) of one of these banks are not compromised. CDS is a joke and the security as a hedge has been exposed as potentially worthless. When these contracts were written no one expected soverigns to be failing at this rate.
The CDS security is traded is a thin market and may not completely price this logic in for some time though and that is the piece that Peter misses entirely.
Tchir has to take Bio 101 where you learn that the tail does not wag the dog.
What he refuses to understand is that while the probability of CDS paying off under a "moderate" sovereign default has gone down, the perception of the probability of the whole system crashing into the basement has gone way up. These two factors have, for the moment, balanced each other. I see the real worthlessness of the CDS's based, not so much on the fact that the Primary Dealers will nullify the trigger, but rather that, like AIG in 2008, they are insolvent, and this time the GS bastards won't get a sovereign bailout.
Separation of banking and state? Ever existed? Even the supposed "free banking era" was heavily government regulated and therefore failed.
The only time this has existed is during time of war. So explain why the American People PAY a private banking cartel to coin their money for them again when the constitution gives them the right to do it on their own? Fuck the banks, they want to get physical, fine with me. The sooner the system crashes the sooner we can find out the true value of everyone's labor. Fucking bring it.
To create a scapegoat and outsource the printing to ensure those making the laws can "distance" themselves far enough to accept the spoils with little political pressure and/or plausible deniability (e.g. insider trading). The FED's "independence" will be a common defense for congress critters in the near future. It is already fiercely defended (e.g. the audit bickering), but it will ultimately be the defense of last resort when answers finally become demanded... "we outsourced the monetary decision making to the market and we were waiting on it to tell us when we couldn't spend any more." Not saying it's the best argument, but you'll see variations of this play out A LOT in the near and medium term. Ultimately, the politicians will have to sacrifice the banks to attempt a shoestring catch of whatever goodwill remains.
Not just violated - more like Jodie Foster on a pinball table level of fucked.
No one worth their salt is buying any EU CDS.
he should have said that the one way flow of power from governments to banks was violated - banks finally forced to do something they didn't want to do. that might be a first
Didn't the separation between states and banking get violated long times ago?
Federal reserve bank system 1913?
Hank "Bazooka" Paulson in 2008?
plus more...
Right-o, banking became an extension of the government as part of central banking.
This is even truer here in Europe than in the US. Here we don't have small banks like the small-town locals and credit unions of the US, mostly just big banks. Some of these are already govt-owned, such as post office banks and 'savings banks'.
So in Europe banks hold a government-granted monopoly. In turn they buy government bonds (why do you think that they are now holding so many of the damn things?). They were buying PIIGS trash long before the ECB had to step in, making me think that they had an understood guarantee of bail-out if things went wrong. (Otherwise why would they have loaded up on such assets? Of course, the Basel rules greased the skids, but it's all part of the same puzzle.)
So banks were covertly implementing EU policy, which is why they have to be bailed out now; if they aren't, future bankers will be much less likely to finance govt borrowing, which has become a political imperative everywhere.
The game must be nearly up, since they're talking about gold-backed bonds for Italy. Good luck seizing your collateral when those default.
'So to say that “CDS is worthless” you would need to argue that a price of 61.5 prior to the “Grand Plan” being announced is worth a lot more than the 61.5 that it is currently worth. Just to be truly annoying, since the CDS trades in $’s, if you convert the price into Euro’s the value has INCREASED, since October 26th, as the Euro has dropped.'
You can't just keep repeating 'CDS isn't worthless' since that ISDA ruling was very sketchy.
CDS is/was a bad idea from the get go.
"CDS is/was a bad idea from the get go." +1
but it's good business! Think about all the US Money Market Managers that are being herded into buying CDS on EU Bonds! It's a wonderful, wonderful business!
The CDS market is shit
And Masters is simply a twit
She wanted more loot
Just like forbidden fruit
She has led us straight into the pit
Do it again with
"The CDS market is bollocks...
Peter Tchir, great stuff you're posting re Europe. Thanks.
Greek CDS aren't worthless in exactly the same way that Dutch tulips aren't worthless.
i dont think that BANKS are afraid of the government ...arent both controlled by the same people...
Worthless in the fact that 61 should be 100 or is it 0. If the ISDA decides to call a Greek default not a default the whole CDS market has been exposed as a failed security hedge. All other talk is just that.
@ Peter Tchir,
The Greek "deal" was looking for 90% private participation.
Are you suggesting that 90% of privately held Greek Debt/CDS is held by entities that are reliant on political/ECB patronage?
ha, i think that the deal is only for IIF members - remember ECB was excluded, and i think i read somewhere that even pensions were excluded, so yeah, probably the bulk of it is at banks and insurance companies, and they still haven't gotten those guys to agree to 90%
Yes oogs66.
Was aware that the ECB and IMF were excluded from the arm twisting.
Wasn't aware that pensions were excluded.
So, as has been pointed out by ZH the true reduction in Debt/GDP is considerably less than 50%.
My point stands of course.
Is Peter suggesting that the banks and insurance companies are so stuffed that they have no choice but to tear up their protection.
If Greece why not the rest?
This is why stock owners in these banks should be zeroed out.
The banks should be turned over to the bondholders and their bonds converted to equity.
And then we could have a fresh new beginning.
Otherwise the entire world becomes zombified like japan.
"Otherwise the entire world becomes zombified like japan"
To the few families that really control capital flows it does not matter. So long as they stay in control and their offspring inherit the reigns of power. Come on now, do you really fucking think these families give a shit if the world looks like Japan? LOL!
The more I read Peter, the more I realize how confused he is.
You might even say in denial.
This article is quite the collection of logical falacies. I understand the effort to kep the con going of course. Faith must be maintained for Greek bonds to be liquidated. Otherwise the music stops and the losses have to be realized.
"No banks have been bankrupted yet by Greece" - If reality is known too soon, they will be. They know it too. The race for the exits will pick up momentum.
That's the way I read it also.
Can't understand how CDS are of any value if arms can be twisted.
Why bother?
it would seem that not enough arms can be twisted? the CDS market is still functioning and according to other posts this morning on zerohedge is setting new wides and inverting - clearly no one believes that Europe can solve anything.
more chatter
Violation of separation of banking and government, LMAO! Central banks are a cartel that were created by governments, of course they are going to do what politicians tell them. If they don't, well, the gubmint will pull their charter. I'd like to see the Bernank tell congress he isn't going to print any more money. That would be must see TV on CSPAN. After DWTS of course.
re:
The Real Reason The "Voluntary" Greek Haircut Is HurtingHmmmm... not sure really- but I'll give it a shot: Is Greek Haircut a euphemism for testicle trimming with a blunt instrument or some such nefarious activity?
Certainly wouldnt surprise me - what with the reputation those guys have got.
"What is interesting is that in spite of these large write-offs of Greek debt, not a single bank has gone bankrupt! What happened to all the people in 2010 said that a Greek default and losses on Greek debt would destroy the banking system?"
There was me thinking the delay of a year was about transferring the banks' debt to the EU institutions so the banks wouldn't go bankrupt from the haircut. If so then the reduced threat of the destruction of the banking system from a Greek default has simply been replaced by the increased threat of destruction of the banking system from Italian, Spanish, Poruguese and Irish default instead.
yeah, all they do is spread contagion, and now they are pressuring the ECB into making the problem worse
And just when I thought that the ISDA Determinations Committee couldn't be any shadier:
http://financeaddict.com/2011/11/catfights-breaking-out-over-greek-bond-...
Good link.
What I think more interesting is the effect of this determination interference on the basis trading strategy.
One would think that the spread will have to be permanently wider to accommodate the political risk.
It hurts bitchez!
libertarian86.blogspot.com
I thought I know a little bit about CDS's, the more I try to learn, the more confused I become.
Is it just me ?
CDS is worthless if your default risk hasnt actually been swapped. 50% W/O with CDS protection shows you that. CDS trading may indicate otherwise but just maybe they're wrong.
"It is a very bad idea to force the ISDA Credit Event Determination Committee to call something a Credit Event, when it isn’t."
You really believe being FORCED to taking a 50% haircut replaced with worthless bonds is not a credit event?
I am reminded of one of my favorite lines from Bill Buckley; "I won't insult your intelligence by actually believing that you believe what you just said."