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Wednesday, January 18, 2012 1:40 PM

Greek Bond Talks Edge Toward 68% Haircut Deal; Will the Deal Be Accepted?

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Former ECB president Jean Claude Trichet said there would be no haircuts. There were. The first Greek haircut was 21% and it was insufficient. The second Greek haircut deal was 50% and that too was insufficient. On each failed attempt, the ECB and EMU poured more money into Greece.

There is now about €200bn of Greek debt held by banks, hedge funds and other investors up from about €50bn a couple years ago.

A third renegotiation is now underway, rumored to be a 68% haircut. Clearly there would have been far fewer ramification on banks if Greece would have defaulted long ago.

Such is the stubborn arrogance of ECB, and EMU officials.

Unless another haircut is approved Greece, and still more money is poured into Greece, it will default on March 20 when a €14.5 billion bond repayment is due.

The Financial Times reports Greek bond talks edge closer to deal

Talks broke down last week with holders of close to €200bn of Greek debt after some eurozone officials called for a sharply lower coupon, or interest payment, on new bonds.

The latest proposal called for a step-up coupon starting at about 3 per cent and rising to 4.5 per cent as the bond approached maturity, one banker said. Another said the average interest paid during the life of the bond would be 4.25 per cent, a rate “that the banks would be happy with”.

The deal would amount to a 68 per cent loss for bondholders in net present value terms, according to people familiar with the talks.
Banks will be happy with a 68% loss? I rather doubt it.

Will the Deal Be Accepted?

Peter Tchir at TF Market Advisors had some interesting comments on the likelihood of the "success" of the PSI (private sector initiative) in his post Greek PSI - Headlines And Reality
The Greek PSI is once again (still) hitting the headlines. Here is what I think the most likely scenario is (80% likelihood).

Some form of an agreement will be announced. The IIF will announce that the “creditor committee has agreed in principle to a plan.” That plan will need to be “formalized” and final agreement from the individual institutions on the committee and those that weren’t part of the committee will need to be obtained. The headline will sound good, but will leave a month or so for details to come out. In the meantime every European and EU leader (or employee) with a press contact will say what a great deal it is. That it confirms that Europe is on the path of progress and that they are doing what they committed to at their summits.

The rating agencies will call it a DEFAULT, because it is. ISDA won’t call it a Credit Event because it isn’t. The EU leaders will call it a haircut or PSI, because they have an aversion to saying the word DEFAULT (and to the truth). There will be some concern that calling it a DEFAULT by the rating agencies will trigger some actions. It won’t. The ECB will allow banks to overrule the declaration of the rating agencies. They will say that Greece remains current on some bonds, that Greece will make payments on new bonds, so this DEFAULT situation is temporary and can be ignored for purposes of accounting, mark to market, collateral, etc.. It will avoid the chaos that would ensue, so they will go with the flow.

Then all talk will turn to Portugal. Why should Portugal continue to pay on their existing debt, when Greece just cut a great deal? And Ireland? The reality that Greece will NOT be an isolated case, but will be the norm will hit, and we will see the market give back the gains and sink lower on the realization that the banks recognizing losses is just beginning.
The key to understanding the negotiation mess is private investors (hedge funds) who bought bonds at a steep discount and at the same time bought credit default swaps for protection have everything to gain by forcing a credit event.

Tchir suggests they will be bought out. Certainly they will have to be bought out or the deal will collapse.

If they are bought out, everyone who does hold out is far better off than those who accept the deal straight up. This is what all the tension is about.

Greek deal disrupted by bondholders gambling on default

It is often hard to tell which article is more current when reading conflicting opinions, but please consider Greek deal disrupted by bondholders gambling on default
"Significant numbers" of Greek bonds may have migrated from financial institutions participating in the voluntary Private Sector Initiative (PSI) to others betting that the country will default, throwing the negotiations into peril, a senior economist has warned EurActiv.

It is also impossible to gauge how much of this ‘bond migration’ has taken place since the PSI negotiations began last year – because of a lack of transparency on the markets – according to Sony Kapoor, the managing director of economic think tank Re-Define.

The deal on the table involves persuading creditors to turn in their bonds and receive new ones that have half the face value and mature many years in the future. The Greek authorities say €206 billion of bonds are subject to the exchange; if all the creditors agree, they’d get €103 billion in new bonds back.

But there is a conflict between those bondholders – represented in the negotiations by the IIF – who are serious about accepting a voluntary write-down, and others betting on a default.

Kapoor said that the interests of bondholders who are hoping to free-ride on a voluntary agreement [some of whom hold credit default swaps] – is irking the bondholders willing to participate in the agreement, and was a major reason for the breakdown in negotiations last week.

“It is a classic collective action problem,” he said. “Collectively a voluntary agreement is in the interests of some of the bondholders. But if 90% of bonds were volunteered and 10% did not, Greece is not likely to default and these 10% may have a bumper payoff,” Kapoor added, explaining why those willing to join the agreement are exasperated with the others.

A spokesman for the IIF refused to comment to EurActiv on speculation that bonds were migrating in significant numbers to institutions hedged with credit default swaps. The spokesman said: “The first priority now for the negotiators representing major institutional investors is to see if it is at all possible to do a deal. If there is one, then the next phase is to see if as many as investors as possible can participate.”

Meanwhile, the Fitch ratings agency announced Tuesday that Greece would default on its debt, although it said that such a default was likely to take place in an orderly manner.

“It is going to happen. Greece is insolvent so it will default,” Edward Parker, the managing director of Fitch's sovereign group for Europe, the Middle East and Africa told Reuters on the sidelines of a conference in Stockholm.
Will the Third Haircut be Sufficient?

Whether the deal is accepted or not I side with that "Greece is insolvent so it will default". But did Fitch mean a "credit event" default or a "voluntary" non-credit event default?

Here is the deal.

The Greek economy is absolutely dead. Austerity measures are going to impart still more pain. Capital flight is underway. Few of the reforms Greece has agreed to have even been implemented. The idea that Greece will reduce its deficit under these circumstances seems silly.

Moreover Greek elections are coming up, possibly "sometime in April", according to the prime minister. Thus, whatever is agreed to now in terms of austerity measures, reforms, asset sales, privatizations etc. by this caretaker government will all have to be fought over yet another time.

Eventually, some politician or set of politicians will have had enough of this process.

Mike "Mish" Shedlock
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