So, the European joke has come full circle. Indebted nations borrow more money to bail out other indebted nations who ask insolvent banks to cut a 50% off deal on the loans that were given to them, but the insolvent banks will then have to raise capital which the will of course borrow from the over-indebted nations whom they just gave money to. Get it? Problem solved - BTMFD!!!
The rally is based off of bullshit and an inability to count. After the voluntary haircut (volunteered at gunpoint, may I add), Greece will still have roughly 120% debt to GDP ratio with a declining economy. Unsustainable still. I would fade this rally with careful stops.
I have went over the Greek debt tragedy in detail with subscribers and things are unfolding exactly as I had anticipated. Before we get to the Greek default rehash, let's peruse an email I received from one of my many astute BoomBustBloggers.
I'm a lawyer (and investor). There is no analysis by anyone on the internet about whether the announcement last night would in fact trigger CDS payout. Rather, everyone seems to be accepting the claim by ISDA that the decision would not trigger it. Because I can't find any legal analysis worth reading on the internet I decided to do my own research. In about 5 minutes I found a case in the 2nd Circuit (USA) that explained to me what's going on with those contracts. First of all, they are unregulated private contracts between private parties. In order to know whether a trigger occurred you have to read each individual contract. As a result, what the ISDA says about whether a trigger occurred as to private contracts that are out there is totally meaningless.
There is merit to this assertion since the ISDA contract is simply a non-binding template, often marked up to accomodate financial engineering widgets designed to increase profit margin and decrease transparency to clients and counterparties. By the time all of the widgets are installed on some of these highly customized deals, the original ISDA template is a non-issue.
What seems to be the issue is whether there is considered to be "economic coercion" going on if one of the events to trigger is "restructuring."
|Whaaattt!!! Coercion? What Coercion???!!!|
Furthermore, you have to not look at voluntariness in a vacuum but compare the (Greek) bond with the substitute being offered by EU to determine if economic coercion or true voluntariness exists. For example, if the EU will give priority in payment to the substitute it is offering and not the original bond, that is the proper analysis in determining economic coercion/voluntariness etc. My analysis here is based upon a very brief reading of the case and I would need time to analysis fully. Also I'm not a financial professional I don't understand all the implications of what the EU announced. The reason I'm contacting you is because I believe that in the coming days/weeks we will hear of entities that are buyers of the CDS protection giving notice of a credit event to their counterparties to seek to collect on the CDS contract. If payouts aren't made lawsuits will be filed.
You had better believe it. I really don't know why everybody is glazing over this very obvious fact! Imagine if you bought protection on a bond you acquired at par and you are offered 50% of it back (NPV) to be considered whole while the CDS writer laughs at and says thanks for the premiums... You'd probably break your fingers dialing your lawyer - out of both the swap payments, the CDS payout, and 50% of your investment that you thought (but really should have known better) was protected!
I don't know what a US Court will decide as to whether a trigger has occurred but there is a 2nd circuit case (the one I mentioned above) that is the best I've found to give an inkling about this... I'm telling you all this, because if I am right and there are claims that CDS was triggered and CDS in fact gets triggered... [it should be made] public so people start analyzing whether CDS was in fact triggered instead of blindly accepting the drivel out of Europe that no trigger will occur. That claim is obviously all about perception management not necessarily truth.
As excerpted from A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina Wednesday, 26 May 2010
The restructuring of the Argentina debt in default was occurred in 2005 when the government offered new bonds in exchange of old securities. The government gave the option of either accepting A) a par bond with no haircut in the principal amount but substantially lower coupon and longer maturity or accept B) a discount bond with a haircut in principal amount to the extent of 66.3% but relatively better coupon rate and shorter maturity than in case of Par bond. If the bondholder accepted A), for each unit of bond, one unit of Par bond will be allotted. If the bondholder accepted B), for each unit of bond, 0.33 unit of Discount Bond will be allotted. The loss to the creditor, which is decline in the NPV of the cash flows, was nearly the same in both cases as the lower principal amount in Option B was offset by better coupon rate and shorter maturity. The price of the par bond in the market and the price of the discount bond multiplied by the exchange ratio (real price to the bond holder) were largely the same when they were listed in the market in 2005.
The IMF estimated the average haircut (decline in the net present value of the bond) was on an average 75% and the market priced in most of this haircut before the actual restructuring in Feb 2005. The prices of the bond in default declined nearly 65% between Feb 2001 and Feb 2005.
One should keep these figures in mind, for in the blog post "How Greece Killed Its Own Banks!"I ran through a much, much more optimistic scenario that wiped out ALL of the equity of the big Greek banks. Remember, the Greek government stuffed these banks to the gills with Greek bonds in order to created the perception of a market for them. As excerpted...
Well, the answer is…. Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)…
The same hypothetical leveraged positions expressed as a percentage gain or loss…
Professional and Institutional level subscribers (click here to upgrade) may access the live spreadsheet behind the document by clicking here (scroll down after for full summary, spreadsheet and charts).
Greek Restructuring Scenarios
There are several precedents of sovereign debt restructuring through maturity extension without taking an explicit haircut on the principal amount, and many analysts are predicting something of a similar order for Greece. This form of restructuring is usually followed as a preemptive step in order to avoid a country from technically defaulting on its debt obligation due to lack of funds available from the market. It primarily aims to ease the liquidity pressures by deferring the immediate funding requirements to later periods and by spreading the debt obligations over a longer period of time. It also helps in moderating the increase in interest expenditure due to refinancing if the rates are expected to remain high in the near-to medium term but decline over the long term.
However, the two major negative limitations of this form of restructuring if applied to Greek sovereign debt restructuring are –
- It solves only the liquidity side of the problem which means that the refinancing of the huge debt (expected to reach 133% of GDP by the end of 2010) will be spread over a longer time period while the debt itself will continue to remain at such high levels. The sustainability of such high debt level, which is growing continuously owing to the snowball effect and the primary deficit, is and will continue to be highly questionable. Greek public finances are burdened by a very large interest expense which is approaching 7% of GDP. The government’s revenues are sagging and the drastic austerity measures need to first bridge the huge primary deficit (which was 8.6% of GDP in 2009), before generating funds to cover the interest expenditure and reduce debt.
Why the Taxpaying Population of Greece Is Still Not Off the Hook, Start Looking Into Stocking Up On Their "Greece"!
Wednesday, 06 July 2011
... Thus, even though the amount of funds required each year to refinance the maturing debt will be reduced by extending maturities, the solvency and sustainability issues surrounding Greece’s public finances, which were the primary reasons for it’s being ostracized from the market in the first place, will remain unanswered.
I'd like to make this perfectly clear and have absolutely no problem going on the record with it in full HD fidelity...
There has been a large amount of capital lent to (and invested in) Greece. The collateral behind (recipient of) said capital has devalued along with popping of the asset securitization crisis bubble to such an extent that it is a mere fraction of what it was valued at when said capital was invested. What does this mean? Well, it means that no matter what financial engineering scheme you attempt to wrap around it (and I happen to be particularly skilled at financial engineering, so I should know), no matter what socio-political financial nomenclature you attempt to drape it in, and not matter how far you attempt to kick said can down the road in a "delay and pray" tactic of pushing the inevitable collapse past your particular tenure at the helm in an attempt to make it someone else's problem... The only way out of this for Greece, Portugal, Ireland and other profligate states is an old fashioned reneging on its payback obligations. A plain vanilla default. The explicit action that unequivocally informs you in no uncertain terms - You ain't gettin' your money back!
The chart above is an obvious reason why Greece not only has an inevitable default in its future, but why the faster they default the better off Greece is as a whole. Reference the test case known as Iceland whose banks default on $85 billion, from Bloomberg:
Debt Raters Miss Iceland Rebound
The credit rating companies that were too slow in predicting Iceland’s economic collapse in 2008 may be underestimating the strength of its resurrection.
Fitch Ratings said in May it may take two years for the island to shed its junk status, while Moody’s Investors Service and Standard & Poor’s give Iceland their lowest investment grades. That hasn’t deterred investors from trying to buy twice the amount offered in last month’s $1 billion bond sale as the island returned to global capital markets less than three years after its banks defaulted on $85 billion in debt.
“When you look at how successful that auction was, it’s clear that investors are now crunching the numbers themselves and that the credit grades from the rating agencies are less relevant,” Valdimar Armann, an economist at Reykjavik-based asset manager Gamma, said in a July 4 interview.
Iceland’s experience shows the rating companies may be overcompensating after failing to identify some of the risks that led to the global financial crisis, said Armann. While Moody’s kept a Aaa rating on Iceland until five months before its banks collapsed, reluctance to raise the island’s credit grade now is blocking the country’s access to a broader investor base. Debt derivatives show the low ratings may be unwarranted as credit default swaps on Iceland indicate it’s less likely to default than euro member Spain.
You see, the only true workable solution is to expunge the debt and have the original debt investors take realize their significant and material capital losses. As it stands now, for political reasons and to maintain the status quo of the existing banking oligarhcy, more debt is being piled onto these nations for the tax paying populace to attempt (and fail) to service! Thus, severe and aggressive austerity plans are being implemented to payback banks and other lenders (at what can be considered usurious terms, enter the IMF), thuse forcing recessionary pressures upon the working populace. This is a thick and heavy shaft, one that is onerous enough to quite possibly require grease for the citizens and denizens of Greece to consider palatable. On the other hand, they can do the Iceland, who is already lapping Greece in both economic growth and demand for its debt!
The situation between the 1st and 2nd Greek (and soon to be Portuguese) bailouts have essentially remained unchanged!
As excerpted from It Should Be Obvious To Many That The Risk Of Defaulting Sovereign Bonds Can Spark A European Banking Crisis
If you think those charts look painful, imagine if the Maastricht treaty was actually respected. Our models haven’t pushed passed 80% debt to GDP, but if you were to put the treaty’s debt ceiling in you would see the very definition of contagion. The following chart represents the first order consequences of a 62% haircut on Greek debt…
Despite the fact that the only way out of this is a true default and destruction of the debt capital proffered during profligate times, TPTB will try their best to find a workaround, because what's best for the people of Greece, Portugal, Ireland and as we have already seen - Iceland, is absolute anathema to the bankers that binged on this stuff at 40x leverage and sitting on 50% devaluations as we speak. You simply do the math: 40 x (-50%) = what kind of returns? Insolvency, first and foremost!
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- Greek Default Restructuring Scenario Analysis
- Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
- Portugal's Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy - Professional Analysis
Here is the rub that all seem to be missing. A 50% haircut to principal is simply not enough - and it appears as if it is by extension and not solely principal - we don't even know if it is to principal yet because thus far all reports that I have come across simply referenced NPV or extensions, which could be a combination of any number of things. As explained above, without an explicit hit to principal, Greece will still be in need of excess Grease, believe it.
My next post on this topic will delve into the BoomBustBlog online subscriber model "Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts" to try and work it out...