[Russ Winter]

“Although the stated intention of political leaders and economic policy makers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to “Black Swans”- Nassim Taleb

Reuters has a piece out that attempts to explain different kinds of default. Once again it is sometimes necessary to read the language first hand to realize just how outrageous this pulling the wool over people’s eyes really is. On one hand the rating agencies have said a debt exchange under which creditors take losses, whether voluntary or otherwise, would be a selective or restricted default.  Under this mechanism CDS credit insurance will be paid. Apparently the operating term is “debt exchange”.  A hard default, is where Greece fails to reach a debt deal and runs out of money, because a deal with creditors is a precondition for securing its second international bail-out on March 20.  I think it will be a forced coercive exchange with the backing of the IMF and Germany.



At least Fitch calls a spade a spade:

“It is going to happen. Greece is insolvent so it will default,” Edward Parker, Managing Director for Fitch’s Sovereign and Supranational Group in Europe, the Middle East and Africa, told Reuters on Tuesday. “So in that sense it shouldn’t be a surprise to anyone. ”We have said for a long time that we don’t think this (private sector involvement) is the way to go, and we would treat it as a default,” Parker said. “It clearly is a default, however they try to spin it.”

How big will the hit be in a coercive exchange? The first chart is what the market thinks of the Greek haircut,  guessing a haircut of about 68%,  well down from October 31, when with great fanfare the parties involved promoted a 50% haircut.    Personally I think the market may have it right, but anybody who speculated on a different outcome, is now in the hole.

source: Zero Hedge



Remember even as late as last July, the number was 21%. Oddly the accounts of the negotiations (see FT,com here) indicate agreement can’t even be reached on a 50% haircut, but clearly creditors are losing the battle, and the damage to creditors grows by the week.  The Troika released its revised projections for total Greek debt/GDP, which was hiked from 149% to 186% by 2013! The IMF is calling for 60%, fair for all parties. Then and only then will agencies such as the IMF step up with funding for the insolvents.  The IMF needs the buy in of China,  and Brazil.

Greece has supposedly been pushing for a steep 75% NPV haircut:  setting a new par of 50%, then trading at half of new par using a small coupon. Judging from the machinations (NYT: hedge funds will sue), it looks like a battle over those details.   Credit Writedowns suggests the stage, but I would use the word forced to forgive for “voluntarily”:

Three aspects of a PSI agreement appear to have been struck. Private sector holders will be asked to voluntarily (my comment: not going to happen, forced or coercive)  forgive half of the Greece’s debt that it holds (~200 bln euros). Of the 50% (remaining)  they will get back 15% is likely to be in cash, to be paid out of the second aid package. Greece and the banks also appear to have agreed in that in principle the PSI should be governed by UK law rather than Greek law.

For the other 35%, private sector will be given a new bond. Here is where the challenge really begins.What should the coupon be on the new bond? The Greek government and the IMF, of course, are seeking a low coupon, with some suggestion (IMF/Germany) as low as 2%, while the group representing the banks wants a 4%+ coupon. There also seems to be some disagreement on the maturity of the new bond, with the IMF and Greece seeking 30 year, while the banks are willing to accept 20-year duration. (I think they split the difference)

What is particularly interesting about Credit Writedowns view is how the ECB loss is handled. To me there absolutely has to be “collective action”. I think this is big, and for these restructures to work the ECB has to eat it too. If the loss on ECB holdings is taken by the EFSF that imparts the cost mostly on Germany and France, and sets a precedent. I am not so sure those countries want or can afford that.

If collective action clauses are retroactively introduced, they would seem to apply to ECB holdings as well. It is not clear how much Greek bonds the ECB owns. Estimates ranges from around 40 bln euros to 70 bln. Regardless of the particulars, the ECB is thought to be the single largest owner of Greek bonds, which it acquired at deep discounts (estimates range between 20 and 30%).

If bond holders are going to vote on whether to introduce collective action clauses, will the ECB vote in favor and thereby risking it holdings? If it votes against will there be sufficient votes to allow for the collective action clauses? What if the ECB abstains?

This underscores the difficult dilemma the ECB finds itself. Participating in the haircut damages the ECB. It is possible that the loss, even from the discounted levels it purchased the Greek bonds, would wipe out the ECB’s capital. Alternatively, as we have point out previously, if the ECB does not take a haircut, it undermines the effectiveness of its sovereign bond purchases. The more the ECB buys the greater the haircut the private sector ultimately faces.

There has been a suggestion that one work around would be to have the ECB sell its Greek bonds to the EFSF at purchase price, which would keep the ECB whole.

Will Greece be funded by the private market after that date? I say in time yes as long as the NPV haircut is sufficient along the line of IMF wishes, and as long as there is reasonable austerity.  The country gradually starts to stabilize and recover and the credit rating improves.  If this is dragged out though or is insufficient (50%), the eventual haircut will be even worse. For the banks and creditors, this outcome for Greece will set the proper model for other insolvents going forward. Greece is round one of a long, bloody fight.

Although much attention is focused on what to call Greece’s impending default,  there is an immediate shit storm going on other fronts; namely Portugal and Hungary. Hungary in particular is intransigent and “difficult”.  The country must repay a €5.9B EU/IMF loan this year, plus raise funds equal to 18% of GDP.  The EU is set to recommend sanctions against Hungary for not doing enough to bring its deficit below 3% of GDP. This sets in motion the next stage of the Excessive Debt Procedure at which the country could be shut out of the EU cohesion fund. For the record: 23 of 27 EU states are running deficits above 3%.

The European Commission has launched legal action against Hungary’s Fidesz government for violations of European Union treaty law and erosion of democracy, marking a dramatic escalation in the war of words with the EU’s enfant terrible. Capital Economics said Hungary must repay €5.9bn (£4.9bn) in EU-IMF loans and raise external funds equal to 18pc of GDP this year, the highest in Eastern Europe. Two-thirds of household debt is in Swiss francs, leading to a lethal currency mismatch as capital flight weakens the forint. ”Hungary is playing with fire,” said Lars Christensen from Danske Bank. “The EU is not bluffing. It will let Hungary go over the edge to make the point that EU countries must play by the rules. Our worry is that Hungary’s government has not yet got the message.”

Austrian banks are exposed to Hungary to the tune of 2.821 billion euros, on top of 736 billion to Greece. Hungary’s debt to GDP at 85%  about on par with “AAA” Germany (who is about to eat Greek losses for starters) , but the main problem is consumer debt tied to the Swiss Franc.  In Hungary, nearly 70% of the country’s total household debt was borrowed in foreign currency. That’s 16% of GDP.   Hungary’s government wants banks to shoulder some of the burden of this, which has invited reprisals.   It is 70-90% in the Baltic States using foreign currency loans. Thus just having Hungary muddle through without currency or banking relief for its consumers, will do little.

Borrowing in cheap interest Swiss Francs during a housing bubble, pay back principal in depreciated Forint during a housing bust, oops!

Swiss France: Hungarian Forint:



Egan Jones downgrades Germany to AA minus, rationale clearly stated, all ties together:

Germany maintains its position as the European Union’s top economy. However, Germany has been shouldering the burdens of other EU countries via its exposure to the EFSF and indirectly via the ECB’s hefty exposure to the weaker banks and the weaker sovereign credits. The country’s debt to GDP of 83% as of 2010 (expect near 86% for 2011) and a deficit to GDP of 4.6% is weak (and getting weaker) for a top-tier country. On the positive side, unemployment was only 6.8% but will probably increase as many EU countries implement austerity measures. Other positives were the positive (EUR133B) balance of trade and the positive (EUR193B) current account as of the end of 2010. Inflation has been fairly moderate at 2%, but we expect an increase as a result of the decline in the euro relative to the dollar.

German chancellor Angela Merkel continues to create tension with EU member states by pushing for ratification of changes to the Lisbon Treaty. The government insists that private investors bear more of the costs of further European bailouts. Note, the cost of the bailouts is likely to be absorbed via increased support for the EFSF, the ESM, the ECB and a rise in the number of euros. The fallout from a likely Greek default needs to be monitored.

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