Friday, January 27, 2012

Hopes Rise For Greek Debt Deal?

Hui Min Neo of AFP reports, Hopes rise for Greek deal as US praises euro salvage bid:
Europe's economic pointman said Friday he expected Greece to agree a deal with private creditors to write down its debt this weekend as the US praised efforts to combat the eurozone crisis.

Speaking at the Davos forum, EU economic affairs commissioner Olli Rehn said the Greek debt agreement may be hammered out before a gathering of European Union leaders Monday, in what would be a major shot in the arm to the summit.

"We're very close," he told the World Economic Forum in Davos. "They're about to close a deal, if not today maybe over the weekend, preferably in January rather than February."

As he spoke in Switzerland, the Greek government in Athens was in talks with private creditors on a voluntary exchange of bonds that would wipe 100 billion euros ($130 billion) off the country's debt of 350 billion euros.

The deal under discussion would see private creditors take a "haircut" of at least 50 percent on 200 billion euros in debt. Previous talks stalled over the amount of interest to be paid on the remaining debt.

Any failure to strike a deal could trigger a messy default, which would be an economic disaster for Greece itself and a threat to banks holding too much sovereign debt while piling pressure on other eurozone states.

Rehn said Greece would remain a special case and that the private lenders would not be required to take losses on any other eurozone country's debt, thanks to plans for a better eurozone financial safety net.

"While I know more or less how the eurozone will look in the next three years, I know that next three days will be very crucial," he said.

"We need a very sustainable solution for Greece, even if Greece is a special case," he told the audience of business leaders and top politicians. "Private sector involvement will not be applied to any other country of the EU."

Speaking at the same debate, German Finance Minister Wolfgang Schaeuble said he expected Greece to avoid a default but he warned its debt level should not exceed 120 percent of GDP.

"We don't expect a default of Greece," he said. "I know that most participants have for a long time, but I don't expect a default from Greece. I'm sure that everybody is ready to deliver what has been agreed."

The head of Germany's top bank, Deutsche Bank, also said he was confident a solution could be found to Greece's woes.

Josef Ackermann said the "haircut", or losses that banks were being asked to take on their holdings of Greek debt, was "almost 70 percent."

"That is a great, great deal. But everyone has to make their contribution and then we will see where we are. We're going to carry on," he told Germany's NTV.

Speaking the day after the Federal Reserve cited the eurozone crisis as a reason for cutting its growth forecast, US Treasury Secretary Timothy Geithner said there were signs a corner was being turned.

"Europe is making some progress," he told delegates. "Over last two months in part they are laying foundations for more credible framework."

"We have three new governments (Italy, Greece, Spain) doing some very tough things, an ECB doing the things you have got to do."

The annual forum has been marked by gloom about the state of the global economy, and in particular about Europe's struggle to cope with yawning public deficits while at the same time seeking growth and jobs.

The euro has been under pressure -- amid fears that Greece or even eventually a giant like Spain or Italy could default on its debts -- and the 17-nation bloc's economy in on the brink of renewed recession.

Davos has reverberated with calls for eurozone nations to act decisively to restore confidence, with Mexican President Felipe Calderon calling on Europe to "bring out the bazooka immediately" to prevent the problem from sinking Italy and Spain.

Geithner said Europe needs a "stronger and more credible firewall" and hinted that the US and emerging economies could supply the International Monetary Fund with more funding to help the eurozone rescue effort.

"If Europe is able to do that, we believe that the IMF can play a substantive role. It can't be a substitute for a European response," he said.

Further fuelling the mood of optimism, Italy successfully passed another market test by selling 11 billion euros ($14.5 billion) in short term bonds at sharply lower rates.

But opposition to a debt deal is mounting. Abigail Moses of Bloomberg reports, Greek Debt Wrangle May Pull Default Trigger:

Opposition to payouts on Greek credit-default swaps from European Union policy makers is softening as disputes over a voluntary debt exchange threaten to push the nation into default.

Any agreement between the Greek government and the Washington-based Institute of International Finance on debt writedowns will only bind 50 percent of investors in the 206 billion euros ($270 billion) of notes being negotiated, Barclays Capital estimates. Hedge funds may resist a deal, seeking to get paid in full or compensated from insurance contracts.

Greece must repay 14.5 billion euros of bonds in March and an agreement that triggers as much as $3.2 billion of default insurance may be necessary unless all bondholders approve, said Marco Buti, head of the European Commission’s economics division. EU Economic and Monetary Affairs Commissioner Olli Rehn said today in Davos that a deal is “very close.”

“Politicians seem less concerned than before about CDS triggers,” said Michael Hampden-Turner, a credit strategist at Citigroup Inc. in London. “Having a payout on Greek CDS is probably better than the alternative: a loss in market faith of the product’s ability to provide a hedge against sovereign risk.”

Worsen Crisis

Officials, including former European Central Bank President Jean-Claude Trichet, have insisted that a swaps trigger was unacceptable because traders would be encouraged to bet against indebted nations and worsen the crisis.

Analysts at New York-based JPMorgan Chase & Co. and Citigroup say a Greek payout may actually bolster confidence in the $232 billion sovereign insurance market and also help boost the government bond market.

Greek Prime Minister Lucas Papademos resumes talks in Athens today with Charles Dallara, the IIF’s managing director, after “some progress” was made at a meeting last night.

Default swaps insuring $10 million of Greek debt for five years cost $6.3 million in advance and $100,000 annually, according to CMA. That implies an 82 percent chance the government will default in that time, assuming investors recover 22 percent of their holdings.

Greek 10-year bonds fell today, pushing the yield on the securities up 16 basis points to 33.64 percent. The price slipped to 21.05 percent of face value. Two-year notes advanced, with the price climbing to 21.33 and the yield dropping 1,814 basis points to 182 percent.

Greece said it may impose losses on investors who fail to support the debt restructuring by adding a so-called collective action clause, or CAC, into its bond documentation. That would force holdouts to accept the same terms as the majority.

Restructuring Event

Use of CACs would trigger a restructuring credit event and a payout of default swaps, according to rules from the International Swaps & Derivatives Association.

Credit events can be caused by a reduction in principal or interest, postponement or deferral of payments, or a change in the ranking or currency of obligations. Any of these must result from a deterioration in creditworthiness, apply to multiple investors and be binding for all holders. ISDA’s determinations committee rules whether swaps can be triggered.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

“A CAC is looking increasingly like the best option,” Citigroup’s Hampden-Turner said. “That route seems to tick a lot of boxes: they don’t have a bond default, the official sector gets treated differently than the private sector, and everybody has to participate in the exchange without anybody getting paid in full.”

ECB Opposition

While the ECB oppose any involuntary restructuring of Greek debt, policy makers such as Dutch Finance Minister Jan Kees de Jager say they aren’t against a credit event.

The softer stance signals Greece is unlikely to get sufficient participation in a voluntary bond swap to make its debt burden sustainable. Negotiations have focused on the coupon bondholders will accept on new debt with Europe’s finance ministers pressing investors to accept bigger losses after the IIF made what they described as their “maximum” offer.

“It would be welcome if the ECB is no longer blocking the only sensible route for Greece to resurrect itself,” said Georg Grodzki, the London-based head of credit research at Legal & General Plc, which manages $550 billion of assets.

Hedge funds in New York and London are trying to profit from trading Greek government bonds as banks brace for losses from a debt swap.

Greek Bonds

Saba Capital Management LP, founded by former Deutsche Bank AG credit trader Boaz Weinstein, York Capital Management LP, the $14 billion fund started by Jamie Dinan, and London-based CapeView Capital LLP are among managers that now hold Greek bonds, according to people with knowledge of the transactions.

Officials are now more concerned about preventing a disorderly Greek default that might threaten indebted European nations such as Italy, Portugal and Spain. An orderly credit event would be positive for the market, according to Saul Doctor, a London-based credit strategist at JPMorgan.

“There’s less emphasis on the perils of triggering CDS,” said Barnaby Martin, a European credit strategist at Bank of America Merrill Lynch in London. “It’s now about making sure Greece’s debt is sustainable.”

Portuguese Bonds

Portuguese bond yields widened this month on speculation the indebted nation may follow Greece in seeking losses from private investors. The country’s 10-year bonds yield 14.88 percent. Two-year note yields are higher at 16.54 percent.

The upfront cost of insuring Portugal’s debt jumped 5 percentage points since Jan. 13 to a record 38 percent, according to CMA, meaning it costs $3.8 million euros in advance and $100,000 euros annually to insure $10 million of the country’s debt for five years.

Outstanding contracts on Portugal have tumbled to $5 billion from about $8 billion last year, according to data from Depository Trust & Clearing Corp., covering 2 percent of the nation’s debt.

Contagion has already happened to a large extent and officials are probably not as scared of triggering CDS as they were six months ago,” said Cagdas Aksu, a European rates strategist at Barclays Capital in London. “If there is any way to avoid the CDS trigger, they will of course prefer it, but the chances of this has become low at this stage.”

Not as scared of triggering CDS? Give me a break! There will be no CDS trigger and no big fat Greek payday for hedgies who bought Greek bonds looking to make a killing.

In his latest comment, Andreas Koutras writes, The Restaurant at the end of the World. Bang or Whimper?:

"Are you going to tell me," said Arthur, "that I shouldn't have green salad?"

"Well," said the animal, "I know many vegetables that are very clear on that point. Which is why it was eventually decided to cut through the whole tangled problem and breed an animal that actually wanted to be eaten and was capable of saying so clearly and distinctly. And here I am." …….

"A very wise choice, sir, if I may say so. Very good," it said, "I'll just nip off and shoot myself."

(D.Adams, The restaurant at the end of the Universe)

Douglas Adams the writer of the Hitchhikers Guide to Galaxy, in his science fiction book the “The Restaurant at the End of the Universe”, has a wonderfully surreal scene. Guests at the restaurant are asked to choose which parts from a live animal they wish to eat, while watching the end of the Universe. The animal voluntarily wants to be eaten.

In a strange sort of way this is what Troika is demanding from Private bondholders. Bondholders are asked to voluntarily kill, or at least half-mutilate themselves while the guests (Troika) are watching the end of Greece. The end however could be either a big crunch (default) or a whimper (no default but just slow death).

This I guess is the 14.4billion euro question (Redeeming on 20th March 2012). Would the end come with a default or would it be just a big whimper? In other words, a slow drift to a cold death with no bangs and no defaults.

My guess is that it all hinges on what the ECB does with its Greek bond holdings. Answering this would in my mind give you almost certainly the answer to the Crunch/Whimper dilemma. Here is why:

Big Crunch(Default)

ECB owns around 20% of the outstanding Greek debt in Bond form. If it is excluded from the PSI then others would free ride on the back of the ECB driving participation down and making the introduction of CAC (Collective Action Clauses) to force it up almost inevitable. There are many problems with this strategy and we have outlined them in previous posts (CAC Warpath, PSI Enigma, ECB and Europe, ECB Accounting).

With or without the ECB, however, there are very few that would gain from a default. Banks holding bonds outright certainly don’t want this. The ECB does not want this as it would mean losses for her and also supporting the Greek banking system. Germany and the EU would have a much bigger problem to solve in an election year. After all, Germany benefits from the lower value of the Euro caused by the Greek crisis.

It would be optimal to stretch the rope to the breaking point but no further. Only a small fraction perhaps less than 5% would stand to gain. The net CDS volume is around 3billion and is insignificant. So, why is it you may ask that they cannot find an agreement to the PSI? To me all this back and forth is just poker playing trying to secure a better deal. Viewed under this light, many actions make more sense. The only problem is that the rope might break earlier and for unforeseen reasons (Greek political turmoil for example).

Big Whimper (Slow cold death)

If on the other hand Europe finds a way to relieve the ECB of its holding or if the ECB decides to take the hit and participates in the PSI, the hold outs would be reduced to a minimum. Namely, to retail bond holders and possibly owners of Greek bonds under English (non-Greek) law. In this scenario, Greece would not need to cause a credit event or introduce CAC’s to force the participation up. It would also respect market practices and give time for reflection and Election (see France, Germany)!

Conclusion

The end game is very hard to call. Rationality and logic point towards a whimper solution. Human failings and unpredictable events point to a big bang. D.Adams motto in the hitchhiker guide to the galaxy is DO NOT PANIC.
Will it all end in a bang or a whimper? I'm not panicking. My take is that the power elite at Davos have enough of the turmoil in financial markets and they will do whatever it takes to put an end to this Greek debt debacle. Stay long risk assets and keep buying the dips hard.

Below, Nobel Prize-winning economist Joseph Stiglitz, talks about income disparity and employment in the U.S., and the European sovereign-debt crisis. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday."

And International Monetary Fund Managing Director Christine Lagarde discusses Greece's progress on structural overhauls and the role of the IMF in avoiding a default. She speaks with Maryam Nemazee and John Fraher on Bloomberg Television's "The Pulse" .

Finally,
George Soros talks about the European debt crisis, stating that defenses for Greece are too weak. He speaks with Erik Schatzker on Bloomberg Television's "InsideTrack" from the World Economic Forum in Davos, Switzerland. As I stated earlier this week, Soros gets it, and European leaders would be wise to listen to him carefully.


No comments:

Post a Comment