While we have done our best to explain what the implications are of the actions of the various parties in the Greek/German/ECB/Euro swap/default/CAC/PSI/Austerity events, it is perhaps worth one more try to address how we see this playing out and exactly what the ECB just did. The weakness in GGBs today along with the rise in the cost of Greek basis packages (a hedged bond trade that looks to profit from a credit event or compression) suggest markets are beginning to wake up to reality but the dead-currency-walking behavior of the EUR (and ES) since last night's close suggests many remain sidelined or have all their chips on the constantly-tilting table.
From Peter Tchir:
Here is how is see it playing out and an explanation of what the ECB has done.
If there was a bond with a billion outstanding and the ECB held 200 million and private investors held 800 million it would make the psi awkward. It would be offered to everyone, but the best case scenario was 80% participation for that bond. So collective action clauses would have had to have very low thresholds (I bet the ECB owns 50% of some issues). It also was hard to make a law that forced holders to participate but excused the ECB. If Greece stopped paying on bonds, it would again be more difficult to pay some holders of a bond and not others.
So in any orderly evacuation of a sinking ship, women and children first. In this case the ECB. There should now be two bonds outstanding. Own for 200 million and the other for 800 million. The ECB will own 100% of the new bond. Those bonds will have special rights and documentation. I don't think the ECB will take an accounting gain (or loss) on the exchange. They will keep it marked "at cost". The fact that maturity and coupon is same as original bonds makes that an easy argument. So this does nothing for Greece. Absolutely zero. TheECB may cut them a check or give them some debt relief but that would be separate. This does none of that. It may or may not have already been done (though somehow I suspect they view it as done but have actually figured out how to legally do it).
So the remaining 800 million of the original billion are all owned by private investors. Will someone challenge the legality of the swap? Can Greece really offer the swap only to the ECB? Possibly, but someone may object. The march 20th bond holders don't need to win the ruling, they just need to delay until march 20th to see if the troika flinches and pays them out at par. So I would expect someone to challenge this swap. Especially if the ECB holds any English law bonds. There are rules for tenders, etc., specifically to ensure fair treatment. While this swap may seem innocuous someone may challenge its legality.
Assuming the swap is done then the troika will start unleashing the weaponry on this 800 million (their 200 million having been nicely barricaded).
Bond holders will be given an offer to exchange old bonds for new bonds. The terms of the new bonds and the exchange ratio will be set. It sounds like investors will have 10 days to make a decision. I would think a lot of banks immediately make public statements that they agree to the terms. They will want to be seen as showing support and getting a big participation number early. Holdouts have no incentive to say or do anything. Delay is their game plan. Expect a participation rate of 85-95% very early. The march bonds will likely have the lowest participation rate as that is the big bet. Other bonds will vary but any that were ideal as a basis package will also likely have a decent holdout percentage.
Supposedly Greece will pass a law making all the old bonds subject to collective action clauses. They have obviously decided it is legal to do this, but time and again they haven't really done their homework. This could be another one of those cases. I would expect some holders of the march debt to challenge this law. I have no clue about the court system in Greece but have to believe someone will try and find a way to challenge a law that applies retroactively. I doubt they win but it is worth a try since the game is to delay until march 20th.
Assuming the law is in effect and the psi deadline arrives, there are 2 possible outcomes.
- 100% of the holders of each and every bond agrees to the PSI. In that case the CACS aren't used and there is NO Credit Event.
- More likely there is one holder of the "default requirement" amount of bonds who holds out (I believe the amount is 10 million, but have to double check that). So in our example 785 million of bonds agree and 15 don't agree. Then Greece CAC's them and they too get new bonds. This IS a Credit Event. CDS would be triggered. This seems the most likely case.
In the end every private holder will write-off 50 percent permanently and those that live in a mark to market world (fewer and fewer live in that world in Europe) probably lose another 20 points or so. CDS will be triggered and we will be told how great it was that Greece avoided a default and that it is an isolated case. All the debt banks issued with a Greek government guaranty will likely be left alone (it isn't the real world anymore).
Is that scenario priced in?