Posted on 10/28/2011 4:29:59 PM PDT by bruinbirdman
Something seems a little off about the latest plan out of Europe, which features a 50% haircut for Greek bondholders.
A complete loss on Greek debt holdings was the other option offered to creditors by leaders like Germany’s Angela Merkel, so by agreeing to take 50 cents on the euro banks render the deal “voluntary.”
That one term carries a lot of weight, since it most likely means the haircuts will not trigger payment on credit default swaps (CDS) that investors purchased to hedge against nonpayment of Greek debt, and that may not be such a great thing.
Calling a 50% haircut “voluntary” may avoid a messy shakeout in Greece, but that relatively small bond market had a small amount of outstanding CDS and the development may have more worrisome implications in bigger bond markets like Italy.
“Risk departments are going to start to say – ‘if we can haircut Greece at 50% without triggering CDS we have to look at our models elsewhere,’” says Rich Tang, head of fixed-income sales at RBS Securities.
If lopping 50% off a bond does not trigger a payout, Tang says, “Who in their right mind is going to buy sovereign CDS protection as a hedge?” Such derivatives do not serve as much of a hedge if they will not protect against a 50% loss event. “Now the only proper hedge is selling,” he adds.
Setting aside the “voluntary” haircuts for a minute, the rest of Europe’s plan raises plenty of questions too. For one thing the planned strategy for recapitalizing banks has a major flaw even before you get to the fact that the ultimate backstop – a levered-up European Financial Stability Facility of about €1 trillion – has no concrete funding.
“The days of private capital coming to the rescue are over,”
(Excerpt) Read more at forbes.com ...
...and if you can't hedge against sovereign default, why buy sovereign bonds at all? Oops, Europe just destroyed their credit markets. Instant balanced budgets for everyone.
Let the CDS issuers go down.
Being able to buy insurance against a debt going bad seems like a con anyway. Risk is part of investing. The myth of the “free lunch” never dies.
Hmmm. In order to get a AAA rating, my city bought insurance on the municipal bonds they issued.
Now, if they chose not to insure those munis, they would have had to pay a higher interest rate because of the risk and the fact that they were not general obligation bonds.
If the city chose not to insure the bonds, one should think the buyer should be able to.
yitbos
That's a great point. It's sort of like buying a life insurance policy and then trying to collect on it without having to die first, isn't it?
> If the city chose not to insure the bonds, one should think the buyer should be able to.
The problem, as I understand it, is that *anyone* can buy CDS insurance against the debt going bad, even one who does not hold an interest in the actual bond. At that point, it becomes pure gambling, not hedging, and can actually be used as a weapon (read, George Soros) to topple an investment.
The EU is too clever by half.
“Solutions” often create more problems than they solve. Particularly when these solutions are devised by bureaucrats and self serving politicians.
Would you buy a 10 year Greek, Italian, Spanish, Portugese, or French bond on Monday without insurance? Just lock up the money for 10 years and hope you get a return, or even your original investment back?
Europeans might think they solved the problem, but they have just turned off the new money supply. Investors who buy bonds, especially government bonds, want safe investments with reasonable returns, like pension funds. They are not gamblers who want to take a chance on 130% Greek debt and see if they get any money back.
Few investors will want to throw away more money on Europe if they can't hedge the risk. There is a whole world outside Europe that will take their money and give a reasonable return for modest risk, and allow it to be hedged.
This just spreads the risk and drives down the credit-worthiness of even the largest European economies.
Spain, Italy...even France are now further emboldened to increase the collective debt of the German people.
This will not end well. The EU is dead, it just hasn't fallen over yet.
It's no longer high finance, we are into the wholly political arena now, and the USA is leading the way.
It can only be used as a weapon in the sense that the holder demands strict payment in accordance with the provision of the contract...or decides to trade those instruments on the market on a large scale. All perfectly within the right of the holder and a foundation of free enterprise.
However, those contracts are worthless in general and ongoing debt deflation. It's time to get THAT part done and over with.
Let it burn down. Build on the ashes.
I have the answer: a circle of safety for all investors! And to put it to the test, simply stand dominoes, each on end, in a large circle. ;-)
It is sadly humorous that the euphimism “haircut” has been so widely accepted as foisted on us by the banksters...
A more honest description of what is going on is that the bond holders (largely the banks) are just acknowledging that their holdings are worth far less than stated book value ... It isn’t a “haircut” that they are “accepting,” it is a reality that they are being forced to accept because they have been unsuccessful in their intention to shift the entire loss to taxpayers through money printing and currency devaluation.
yitbos
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