Greece Needs Money to
Avoid Default, But Complications Arise
Europe's financial issues have all the ability to gravely
effect U.S. propositions. We have witnessed in the past, starting just last
December, a stable climb in equity values. This climb is certainly coincident
with the European Central Bank's (ECB) release of billions in loans to European
banks. Not only a form of quantitative easing, but in reality a thawing of frozen
European bank liquidity.
Presently, equities are moving sideways or otherwise
stalled—as if they hold suspense in whether an economic shoe will drop.
Certainly such is the case. For Greece; its debt, the exposure of this debt to
world banks, and credit default swap parties, all swing in the balance, only
for all to wonder of net losses.
Firstly we have Greece's need to reduce its debt. Aside from
simply cutting its fiscal budget, the call is for Greece to reduce its
sovereign bond payments. To make the reduction, private bond holders have been
identified as targets. Where the taxpayer supported ECB has negotiated an
exemption from loss, private bond holders will take a loss. Private bond
holders are primarily composed of European banks, tied to international money
like Lehman.
Cuts to bonds are 53.3% of face value, as negotiated by the
International Institute of Finance, lead negotiator for the private sector. A
53.3% reduction in outstanding bond payments (or redemptions) comes from an
effort of Greece to cut its fiscal budget, on the debt side, by 170B euros.
Cuts to bond payments are demanded by the Eurozone for Greece to receive its
second round of bailout money. Greece needs a second bailout, of real cash, by
March 20.....to make a 14.5B euro bond payment.
Who Wants to Take Half
Off Their Investment
Cutting Greek bonds by 170B euro seems fairly expected and
anticipated. Greece's fiscal budgetary cuts, however, are still very slippery and
hard to hold. Currently, the goal is to see if the 53.3% cut in bond asset value
will be accepted by private bond holders. The agreement due date for private
bond investors is March 8.
Greece is hedging its own participation in bond
reductions by saying that if 90% of bond holders don’t agree to stated cuts, it’s
not obligated to continue with the plan. Big questions remain in an event bond
holder participation is in the 75% to under 90% range. Should such a range
develop, Greece says it will consult with the public sector.
Naturally, the glitch is that private bond holders aren't
really excited to lose 53.3% off the top of their investment. Add to it
lost interest over the period of the bonds, and some say 70%. For large
investors, these issues are why credit default swaps (CDS) are purchased.
A CDS is simply
insurance purchased against loss on an investment. Should a bond issuer default
(Greece), the CDS pays a negotiated percentage of the purchase value of the
asset. CDS platforms get the asset and you as purchaser get the negotiated
payment.
A key event that leads
to CDS payment is default. Defaults are called credit events. A credit event
can occur when one creditor is given payment priority over another
creditor....subordination. Another credit event can occur when a majority of
creditors take a reduction in payment or terms of payment, involuntarily.
Credit Default Swaps
Could Cover the Losses
Looking to lose money, obviously anyone bondholder will get
curious about their insurance policy. Curiosity is addressed to the
International Swaps and Derivatives Association, which monitors CDS's. Because
CDS's are essentially insurance policies, CDS questions are analyzed according
to contract law. This means that if
certain terms are not addressed in the CDS agreement, they will be addressed by
Agency interpretation, rules, statute, or court rulings. In the end, there are
no statutes, rules or court decisions. Which leaves agency interpretation as
the law.
Euro bond holders asked two questions of the ISDA about their
CDS insurance:
1)
If creditors (bond holders) take a reduction in
obligated payments on a bond versus the ECB not taking a reduction, is that a
subordination? That is, where private investors take a cut in principle, but
the ECB’s principle is the same, is that a subordination.
2)
If creditors submit to a bond cut of 53.3%, in
numbers sufficient to bind all creditors, (2/3 of bond holders of record based
on the Collective Action Clause), does that result in a credit event (default)?
Maybe Credit Default
Swaps Work, Maybe Not
The ISDA answered both questions saying no credit event is
implicated at this time. For the ECB question, ISDA officials said documents
addressing the 53.3% bond reduction mentioned no subordination. Though in
reality it’s a subordination of creditors to other creditors, it’s not
according to the ISDA.
Binding all bondholders through the Collective Action Clause
is another issue. The Collective Action Clause is a product of legislation
recently passed by Greece having retroactive effect. It requires that once 2/3
of bond holders agree to a measure, such measure can be treated as a collective
act, and imposed upon all bond holders. It’s akin to collective bargaining, and
its associated laws.
Should the Collective Action Clause be enforced by Greece,
the bond reductions will not be voluntary at that point. By implication of the
ISDA’s decision, such enforcement of the clause by Greece will be a credit
event triggering CDS payments.
Bottom line: 1) Greece needs a second bailout of 130B euros
to make a March 20 payment on bond redemptions of 14.5B euros. 2) Greece needs
to cut 170B euros of debt and the Eurozone expects it to come from private bond
holders. 3) The International Institute of Finance negotiated at 53.3%
reduction on behalf of private bond holders. 4) March 8 is the due date to see
if private bond holders will take the voluntary reduction. 5) Should 90% of
private bond holders not accept the reduction, Greece will have to make a move
against public entities holding their bonds. 6) Should the Collective Action
Clause be invoked, or Greece not meet the demand of cutting 170B euros, a
credit event is likely and will trigger CDS payments.
Success for this plan hinges on March 8, and whether private bond
holders participate to the tune of 90%.
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