Why It's Actually A Big Deal That Greek Bond Haircuts Talks Have Been Suspended

TBI ^ | 10-26-2011 | Simone Foxman

[blam]

Why It's Actually A Big Deal That Greek Bond Haircuts Talks Have Been Suspended

Simone Foxman
Oct. 26, 2011, 9:53 AM

Talks on the losses private Greek bondholders will take are deadlocked and have been suspended.

This news just hit the wires from Bloomberg. So far, U.S. markets don't seem to care.

However, this could be a big deal, for two reasons:

- Debt sustainability in Greece is virtually impossible without significant writedowns of sovereign debt. The numbers are just too big to allow for anything else. More private sector involvement (perhaps coupled with public sector involvement) is seen as absolutely necessary at this point. Don't forget that this will probably be followed with some level of bank recapitalization.

- Market chatter is that these haircuts could end up being involuntary. While we're not sure exactly what this might do, the concern is that involuntary PSI could trigger a credit event. This would have massive implications not only for Greece but for the global economy because it could trigger the fulfillment of credit default swap contracts. Who knows how far these implications would extend?

Meanwhile, everyone's still waiting on that letter from Berlusconi.

[blam]

The DJIA opened up 132 and is at 86 as I post, see here.

[blam]

Silvio Berlusconi 'Makes Secret Pact To Step Down' (Italy)

[MinuteGal]

What's the "awaiting the letter from Berlusconi""

Is it like the Letter to Garcia...or the Scarlet Letter?....or the Letter to Three Wives?

Breathlessly awaiting.....

Leni

[dynachrome]

Probably got suspended because all the numbers are fraudulent. No one knows the true amount owed. And the Greek gov’t will not make it to the new year if the goodie train is derailed.

[longtermmemmory]

what is the euro currency doing? with this type of news it should be crashing.

[NeverForgetBataan]

“So far, U.S. markets don’t seem to care”
______________________________________________________________________________________

The DJIA is just re-arranging the deck chairs right now..... before the lifeboats get lowered.

[BfloGuy]

What's the "awaiting the letter from Berlusconi""

I don't know, but I heard Godot was on his way, too.

[Pelham]

“trigger a credit event”

This is the big danger.

A “credit event” is what set off our current great recession.

In our case it was Lehman Brothers’ bankruptcy.

While letting Lehman Brothers fail didn’t seem that significant, it triggered massive liabilities in the Credit Default Swaps market which spread throughout banks and financial firms all over the world.

[traderrob6]

Hate that term “haircut” It implies something that is not hurtful and fairly benign in it’s effect.

Nothing could be further from the truth.

[AnAmericanAbroad]

So that’s where Godot is.

He said he was coming by for a cup of coffee and some conversation about existentialism this afternoon. Been waiting three hours.

You just can’t count on some people.

[AnAmericanAbroad]

I can’t help but wonder what the amount of CDS’s on a Greek default is (in trillions of dollars). Or an Italian, Spanish, Portugese, etc. default.

I think it must be pretty substantial, or otherwise the EU (and everyone else) wouldn’t be running around like chickens with their heads cut off trying to delay the inevitable.

[Nervous Tick]

>> Hate that term “haircut” It implies something that is not hurtful and fairly benign in it’s effect.

LOL! Yeah, it’s usually more of a “scalping”.

While painful, I suppose that is still to be preferred over a “decapitation”.

[SAJ]

Pelham, you avoid the potentially disastrous effect of triggering a huge batch of CDSes in the same way you minimise the effect of the inevitable Greek default: haircuts.

The bondholders take (or are forced to take) a haircut. Similarly, make the owners of CDSes take a proportional haircut on their payout. This lowers the stress level enormously for the grantors of CDSes, who are mostly investment banks. Sure, many times the bondholders also own CDSes and so they will take a double hit...but that's life, that's the market.

And just who, in any case, asked the bondholders to buy any of these crappy bonds in the first place? It isn't as if Greece (and Italy, and...) were ever stellar credit risks in the past 60 years, now is it? The bondholders were chasing yield, and their chase came back to bite 'em in the arse.

The bondholders NEED to take a sizeable hit here, in the interest of restoring mkt discipline. And so do the CDS owners. The moral here is: when you make a bad investment decision, YOU MUST LOSE SOME CAPITAL, otherwise -- as we have seen for the past 4 years -- moral hazard runs rampant.

[Malesherbes]

Great comment. I think Godot was scheduled to arrive on the Titanic, but he is 99 years late.

[RedEyeJack]

“The bondholders NEED to take a sizeable hit here, in the interest of restoring mkt discipline. And so do the CDS owners. The moral here is: when you make a bad investment decision, YOU MUST LOSE SOME CAPITAL, otherwise — as we have seen for the past 4 years — moral hazard runs rampant.”

Of course, if you bought GM Bonds Obama would give you the ultimate haircut... a 100% loss on you bond investment so he could move the residual capital to the UAW pension fund... more like a decapitation than a haircut. Doesn't the constitution say something about the need for due process before you are deprived of property by the government... How's that working for you?

[SAJ]

Not comparable. The GM bond debacle was simple confiscation of private-market capital, no more and no less. Further, the GM bondholders (of whom my sister is one) had purchased instruments that were AA+ at the time of purchase and had paid their coupons reliably for years. Yes, GM **might well** have had to default or haircut some series of bonds, but they did not do so: Osamabama and his union cronies simply said, "Bonds? What bonds?"

Sovereign debt is an entirely different animal. Whereas GM and other corporate bond issuers must pay interest and ultimately principal by earning profits, sovereign debt is paid off (IF it's paid off) via taxation of citizens. And, in the Greek situation, bondholders (well, the sane ones at any rate) understand that there is no chance at all that they'll be repaid in full. Both bondholders and would-be bond guarantors -- whether EMU, ECB, or individual members of EMU -- are only arguing over the level of haircut that will eventuate. No one is arguing for full repayment.

[NVDave]

A “credit event” was NOT what set off our current recession.

The NBER put the start of the current recession as December, 2007. Lehman tipped over early in the morning of September 15, 2008.

The recession is and was caused by the consumer’s inability to lever up any more to increase consumption. Effectively, the warning sign was on the wall in early 2007 when borrowers of home equity lines and first-time mortgages started defaulting from the very first payment. There was no more money with which to service new debt. After that, it was a certainty that debt deflation would follow.

Household incomes stagnated since 2002, and with the backslide we’re seeing now, consumers have had (on average) no increase in organic (ie, non-credit) purchasing power since about 1998. The US economy is effectively broken, and easy credit was able to paper over the problems until we ran out of credit to extend to the consumer. You’re seeing the exact same thing happen in student debt now as happened in home construction and sales, as happend in autos, etc.

[NVDave]

The really odd thing here is that the bondholders were pitched a deal a couple months ago to take a 21% haircut and be able to walk away. They refused and now they’re being told that a 50 to 60% cut is what is now under consideration.

These idiots in European banking must be really, really, really stupid, because I’m only slightly familiar with the numbers out of Greece and I would have been *all* over that 21% deal, saying “Where do I sign and in how many languages?” Because while I might not know the exact numbers, I can look at the recent trajectory of the Greek economy and see that they’re going to default on a lot more paper as their economy swirls down the drain and then pulls in the drain stopper after them. Their protests, strikes and work slowdowns are killing them, which leads to new rounds of austerity talks, which leads to more slowdowns and strikes... lather, rinse, repeat.

The problem could have been contained for awhile with a 21% haircut. It might have gained the Greeks a little breathing room to let the crowd fury die down because the Germans wouldn’t have had to make new demands every single week for more Greek budget cuts in order to get the bankers to agree to haircuts. But no, everyone decided to buy the jumbo cup of steamin’ stupidity, so here we are, talking of 50%+ haircuts and that will likely result in some Frog and Kraut banks tipping over.

Sigh. So much stupidity, So many people in dire need of a really good beating with a piece of pipe.

So little time in which to do it.

[ctdonath2]

Godot Action Comics

[SAJ]

Agreed, Dave. Were I a Greek debtholder, I should have taken the 21% haircut at the speed of light. Don't think that that 21% deal would've flown, though; the French banks were whining at 800 decibels even at that number. They're doubtless apoplectic at the thought of a 60%+ haircut.

Eurobankers seem stupid because they operate almost completely under a different set of assumptions. The most pernicious one has been around for a couple of hundred years, to wit, that the state has a duty (and a cash obligaion...) to preserve them, almost no matter what. Every time someone points out to them that this assumption is lunatic in an objective world, they throw up the Kredit Anstalt and Herstatt fiascoes as wishful absolute defenses to the argument. You'll never change this attitude w/o a major collapse, either.

Just BTW, my back-of-the-envelope (and thus not necessarily reliable) calcs show that a requirement for a 72% haircut on all Greek sovereign debt would produce **roughly** a 50-50 chance of Greek fiscal stability for a period of one year. Obviously, the unknowable here is whether or not Papandreou et al. are serious about the drastic budget cuts necessary, and HOW serious they are. Hence the 50-50 result.

I can hear SocGen and BNP Paribas screaming from here.