Monday, July 4, 2011

Another 400 Years of Tyranny?

It's 4th of July, markets are closed and it's quiet. Wanted to follow-up on my last comment on saving the world. My friend sent me additional comments on ratings agencies engaging in questionable activities after he read this Bloomberg article, Greek Debt Plan May Place It in Selective Default, S&P Says:

Standard & Poor’s said the debt rollover plan for Greece may temporarily place the country in “selective default” if the French plan allowing bondholders to roll over their debt is implemented.

The French proposal would qualify as a distressed debt restructuring because it offers creditors “less value than the promise of the original securities” and would therefore put Greece in default, S&P said in a statement today.

Europe is inching toward a goal of getting banks to roll over 30 billion euros ($44 billion) of Greek bonds, instead of opening a hole for the official lenders to fill. French banks, with the biggest holdings in Greece, worked out a rollover formula that is serving as an example elsewhere, with two options for bondholders to replace their maturing securities.

“It is our view that each of the two financing options described in the Federation Bancaire Francaise proposal would likely amount to a default,” S&P said in the statement. “But, once either option is implemented, we would assign a new issuer credit rating to Greece after a short time reflecting our forward-looking view of Greece’s sovereign credit risk.”

European Central Bank President Jean-Claude Trichet reiterated last week that the ECB opposes “all concepts that are not purely voluntary” and called for “the avoidance of credit events or selective default or default.” He declined to comment on the French proposal.

Fitch Outlook

S&P would assign a “D” rating to the maturing Greek government bonds “upon their refinancing in 2011,” it added. All debt issues would then “likely” be rated at the same level as the new Greek rating afterwards.

“They are clearly creating a problem with what has been discussed,” said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. “It’s a risky exercise and it looks from S&P’s perspective that they’re going to take no prisoners on it. It will be a downer for the periphery, above all for Greece, and will give bunds a bit of support.”

Fitch Ratings said June 15 it would probably keep ratings of Greek government bonds above default level if European Union leaders go ahead with plans for investors to voluntarily roll over their debt, while lowering Greece’s issuer rating to “restricted default.”

European finance ministers have authorized an 8.7 billion- euro loan payout to Greece by mid-July, basing a second three- year bailout package on talks to corral banks into maintaining their Greek debt holdings.

Different Options

Under one option of the French plan, private investors would reinvest 70 percent of their original holdings in 30-year Greek bonds, with the remaining 30 percent paid in cash on maturity. Greece would use 50 percent of the original amount to meet its financing needs with the remaining 20 percent invested in zero-coupon bonds through a so-called special purpose vehicle to serve as collateral to insure the banks get their principal repaid.

The new 30-year bonds will have a coupon of 5.5 percent with a bonus based on the growth of Greek gross domestic product of up to 2.5 percentage points. The special purpose vehicle will invest in AAA-rated securities that will be held as collateral to protect the banks against a Greek default or be used to pay off the new 30-year bonds at maturity if Greece remains solvent. The second option of the French plan foresees rolling over at least 90 percent of the maturing bonds into new 5-year bonds with a 5.5 percent coupon.

And here are my friend's comments:

This is an example of how rating agencies have become much too powerful and where the timing of their comments are suspect.

The plan put forward by the French Bankers is a voluntary roll-over of debt with new agreed terms and conditions. There is no default here just an agreement. The interest rate has been clearly set below market but again this is voluntary.

S&P has now stepped into the discussion and put a monkey wrench into the process. By calling this a selective default, they trigger all sorts of negative covenants on the existing debt as well as cross-default covenants on other debt and any covenants on CDS written on the existing debt.

Therefore, the rating agency is now providing an opinion on the definition of a default. They have no business doing this. Default is actually a legal principle and one that only lawyers can opine on based on the specific loan documentation between the Borrower and the Lender.

In my view, the French banks have shown some leadership here and they should be praised for devising solutions that help, perhaps even provide a long term sustainable solution, rather than aggravate.

As you can see, I have to question S&P's motivations because their actions serve no other purpose than to add volatility to the credit markets. Why would they choose to do this? What value are they adding to the debt markets here? Why are they unable to wait until after a deal is struck to assign a new rating on the Greek debt?

The list of institutions that can benefit from this behaviour is quite short. They need to be able to trade on the securities. This is probably a very small subset of hedge funds or investment banks that can actually do this.
I suspect that the existing loan documentation is not clear on the definition of default (which is often the case with sovereign debt). By providing their guidance, they actually provide the foundation for legal claims for the institutions actively trading the debt or instruments associated with the debt.

Is this really the primordial function of credit rating agency? I do not think so.
I shared these comments with other pension fund managers this morning one senior pension fund manager responded:
The problem with default or no default lies with all the CDS protection bought and sold on Greece. A negative basis trade, where one buys Greek paper and then buys protection on Greek default is the problem. What does one do? I was pitched this trade and the reverse trade as well...didn't like both..coin flip on both! Bill Gross said it. If this doesn't create a default then it's the death if sovereign CDS. He right and he's probably talking his book!

Apparently many banks in Germany bought protection on their Greek paper they own. Tough luck for them..many it was french banks that sold it to them?

It wasn't just German banks, but German and French pension funds that bought protection on Greek paper. That's the real reason behind the Greek bailout.

I had a chat with another Greek Canadian friend of mine, a trader in Toronto, and we went over what's going on in Greece. Below, in point form, are the key points from our discussion:

  • On Greek default option: My friend told me "they can't default before they balance the budget." I asked him how are they suppose to balance the budget with all these savage cuts and people losing their jobs as Greece implements strict austerity measures? He responde: "that's what happens when the IMF comes in, but if you exclude the interest payments that are now running close to 25%, they can balance the budget if they target growth." (see below).
  • On the "Hellenization" of Western economies: My friend told me that Nobel Prize-winning economist Paul Krugman was in Toronto last week warning against fiscal conservatism: “The greatest damage that Greece has done, is not the actual loss that will be suffered when they default, but they have warped the economic debate,” he said. “The fact of the matter is that nobody is Greece except Greece.” I submit that the economic debate was warped long before Greece imploded. Krugman and Joe Stiglitz, another Nobel Prize-winning economist, are right to point out how absurd it is to worry about debt and implement austerity measures when the real crisis is the jobs crisis. Importantly, if countries don't bolster meaningful job creation, then no matter what austerity measures they implement, their debt profile will only get worse.
  • On opportunities in Greece: We had an interesting discussion on opportunities in Greece. Told my friend that I was watching Greek news this morning, and apparently Euro technocrats are demanding a place in some Greek ministries to "monitor" activities (embarrassing but the Greeks deserve it!). Told my friend this is the beginning of another 400 years of tyranny for Greece: "you're going to see a fire sale on Greek assets." We discussed opportunities in Greece. My friend pointed out that with cotton prices rising to record levels in the last year, Greece's cotton industry has room for confidence. We talked about casinos and how Greece can easily become the next Monte Carlo. I even suggested southern Crete, which I consider an undeveloped paradise on earth (don't really want to develop it, but if done properly, this is going to be a huge revenue generator for the Greek government). We talked about Chinese-Greek, Russian-Greek and Israeli-Greek alliances to explore oil in the Aegean and to develop solar farms in Greece. As my friend said: "The Greeks better choose their friends in the region wisely, and if they do, these alliances can be mutually beneficial." The point is there are plenty of opportunities if Greeks get their act together. But the risks are high now, and one senior Canadian pension fund manager wrote me this morning he's not biting on Greece just yet: "I'm a little nervous about the potential for Greeks taking revenge for being forced into an asset sale. I always ask 2 questions: is this a good deal for me and is it perceived to be a good deal for my counter-party?" Fair concern, but I believe if the terms are fair, Greeks will be forgiving.
  • On Greek nationalism: Greeks are proud of their history and heritage. My friend in Toronto and my friend in Vancouver are tired of hearing people shit down on Greece and so am I. This morning I circulated an article on new research examining the cellular events that lead to multiple sclerosis (keep taking high dose vitamin D and N-acetylglucosamine) and noticed the doctor leading the group of researchers from the UC Irvine MS Research Center is Dr. Michael Demetriou. Told my friend: "If Greeks ever got their act together, we can be just as strong as Jews, but the problem is that Greeks only think individually, not collectively." My friend agreed and pointed out to the Greek shipowners making billions in profits and not putting the bulk of the money back in Greece. "There is no more pride left, no sense of nationalism." We're all tired of people frowning on Greece. I even got hate emails from US citizens telling me that Greece is the scourge of the world. I politely reminded these people that if the US wasn't able to print its own currency and if it didn't have the world's most powerful military, it too would be up shit's creek.
  • On American pride and independence: I asked my friend if he saw 60 Minutes last night and the story of Elissa Montanti, an incredible lady and her charity called the Global Medical Relief Fund (see video below). Told my fiend that I donated $100 and that "disturbingly this lady received hate mail from Americans who think she's aiding future terrorists. My friend shared with me a story that his father shared with him. After the second World War, Americans came into Europe with food and clothes. They were admired and looked upon as saviors. No longer. Nowadays, they are looked at with contempt and disgust because of the wars in Iraq and Afghanistan, the greed on Wall Street, and the general sense of frustration that the world's greatest superpower is not going down the right path and dragging the rest of the world with it.
On that note, I'm heading off to enjoy another gorgeous day in Montreal (benefits of unemployment and answering only to yourself!!!). I wish all Americans a Happy 4th of July and leave you off with the story of a great American, Elissa Montanti, an incredible lady and her wonderful charity called the Global Medical Relief Fund. Please donate generously to this charity and to all the pension funds and hedge funds reading me, force your brokers to send commissions dollars to this charity. These kids don't deserve to live a life of agony because of greed and stupidity.


A reader shared these thoughts:
Your blog is of course your opinion. But I wish you would stop making blanket statements where you link "Wall Street greed" with America.

First, as I am sure you well know, Wall Street is not just a place but a euphemism for the entire financial community (theoretically, you included). As such, it has no geographic boundary but includes any and all financial institutions globally. The place itself (Wall Street, New York City) is today virtually bereft of financial institutions (with of course the exception of the NYSE).

Second, Wall Street (in this case, meaning finance or the financial industry) is not dominated by Americans. Financial professionals are of all stripes and hues, all ethnicities and religions. You are Greek-Canadian; I am Flemish-American; there are Asians, Africans, Europeans and others. As such, it is hardly a tool of American foreign policy (if it ever was).

Third, the companies that dominate this sector of the economy are also multinational. Some American firms are in the top tier but others are European or Asian as well. So again, hardly a monolith.

Fourth, as one of your other readers mentioned to you recently, you hardly endear yourself to others when you employ stereotypes in your posts. It smacks (to me at least) of thoughtless populism. It may play well when running for office to bash "greedy Wall Street" with a subtext of America, but since I don't think you are running for office, your posts (like this one) reads to me (and likely every other American) that you harbor a deeply ingrained anti-American bias. Of course if you do - and the schadenfreude you engage in certainly makes it seem that way - that is of course your right. But by stating it in the tone you do (echoes of the 'anger' that one of your buddies recently advised you on) you simply alienate us.

Finally, and underscoring my first point, Americans have no monopoly on "Wall Street greed". Bernie Ebbers, of Worldcom fame, was a Canadian. Millions of Americans took a hit thanks to his shenanigans. In my hometown of Chicago, the Montreal native Conrad Black robbed one of our two major newspapers, The Chicago Sun-Times, blind causing job losses and all sorts of grief here. In fact there is even a whole wikipedia category (which is incomplete) of Canadian fraudsters (see here ) but you hardly see Americans making broad, accusatory statements about Canadians.

One concluding thought. Officially you are not selling anything. But you are in effect trying to sell yourself as an expert in the pension space (which I think you of course are). It is a good strategy and I think it makes eminent sense. Perhaps, as you have stated before, you are also looking for gainful employment based on that expertise. You can be that expert and attract comments and interaction from others without needlessly antagonizing others. At the end of the day, though, as we both know, people buy from or do business with people they like. If you start off by telling a portion of your readership how much you dislike them, they will tune you out. And then everyone loses.
To which I replied:
You wrote "stop making blanket statements where you link "Wall Street greed" with America." You TOTALLY misread me!!! Americans are great people, which is why the world looks up to them. The current shenanigans on Wall Street are NOT what America is all about, which is precisely my point!
So please, do not take my comments as anti-American, far from it!

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