Skip to comments.Why It's Actually A Big Deal That Greek Bond Haircuts Talks Have Been Suspended
Posted on 10/26/2011 7:21:27 AM PDT by blam
Why It's Actually A Big Deal That Greek Bond Haircuts Talks Have Been Suspended
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.
(Excerpt) Read more at businessinsider.com ...
Is it like the Letter to Garcia...or the Scarlet Letter?....or the Letter to Three Wives?
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.
what is the euro currency doing? with this type of news it should be crashing.
“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.
I don't know, but I heard Godot was on his way, too.
“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.
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.
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.
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.
>> Hate that term haircut It implies something that is not hurtful and fairly benign in its effect.
LOL! Yeah, it’s usually more of a “scalping”.
While painful, I suppose that is still to be preferred over a “decapitation”.
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.
Great comment. I think Godot was scheduled to arrive on the Titanic, but he is 99 years late.
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?
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.
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.
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.
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.
Here’s a question to which I truly do not know even the beginnings of an answer:
How much are the Greek pension system(s) invested in Greek sov paper?
Because a 50%+ haircut is going to screw the pensioners and current older employees so badly that I could see a lot more domestic instability by the “productive class” of people (ie, those who are still working) if their retirements are hit that hard.
re: the French banks. You’re so right. The French business sector, in general, is the most crony-capitalist I’ve seen outside tin-pot third world dictatorships. It isn’t just their banks. It is their media companies, their water companies, their oil companies, you name it. They’re all in bed with the government.
BTW, on Anstalt, et al. I’ve found that in studying the Depression and the banking crisis of ‘29 to ‘34, that the issue of war reparations is hugely fascinating. And studying the issue of WWI reparations led me back to the “cause” of the Versailles treatment of Germany, which was the reparations schemes from the Franco-Prussian war, in which the French were forced to pay Germany. Hugely fascinating subject in history, which ties into the banking systems in ways I had not previously imagined. For example, the “Long Depression” of the 1870’s here in the US, in which we had a debt deflation depression/recession in the latter 1870’s, and kicked off by a railroad bond collapse in October 1873, and that unsustainable boom was brought about by Germany investing reparations in the US rail bond market.
As I said, hugely fascinating. It is fascinating to see how European finances and bankers keep showing up at the scene of economic devastation time and time again, through some of the most indirect of couplings...
The Treaty of Versailles was arguably THE most disastrous attempt at war-revenge ever enacted. In addition to what you cite, the Treaty was directly responsible (but not solely) for the post-WWI degradation of the French Franc, the Weimar inflation and the collapse of the worldwide gold standard in the 1930s. Perhaps I've missed out a worse example, but until one is supplied, I'll go with Versailles as the worst.
Yeah at 50% it’s more like Decapitation....
“I cant help but wonder what the amount of CDSs on a Greek default is (in trillions of dollars).”
The US mortgage market was supporting trillions of dollars of derivatives atop the underlying mortgages. It was an inverted pyramid, the number of mortgages being smaller than the derivatives piled on top of them.
Credit default swaps are actually more of an insurance product than a derivative, despite how they were traded.
One dangerous feature of them was that the swaps weren’t limited to just the two primary parties involved, the party wanting to insure a mortgage product and the party offering to insure it.
Anyone could bet on that same deal; so a particular mortgage or CDO wouldn’t have just two parties involved, it could have hundreds. That’s why the number of derivatives reached such staggering numbers.
And it looks like many investors, and that includes banks, didn’t fully understand what they were buying. A CDO is a bundle of loans, debt, mortgages; it is an asset. A CDO-Squared is a bundle of CDOs, also an asset. If your asset goes sour you can at most lose the amount of your investment.
But then there are Synthetic CDOs, and these aren’t bundles of CDOs, they are bundles of credit default swaps. If you buy them you aren’t buying an asset, although you might think you are, you are buying a product that pays you a premium but also includes the potential of a huge future liability. It ends up being somewhat similar to naked shorting a stock; your gain is known, your potential loss could be enormous.
Gillian Tett’s excellent book “Fool’s Gold” provides an education in derivatives developed during the 1990s and how they came to be. Their complexity seems to have fooled even some of their developers. I have no doubt that they fooled many who traded them.
A good portion of the great recession has its roots in the derivatives market, as well as in another obscure pricing tool from the collaterallized mortgage market, David X Li’s Gaussian Copula Function.
Just as with Black-Scholes-Merton, or Whaley, or Cox-Ross-Rubinstein, a pricing model ONLY works if one obeys the underlying assumptions...and only if the market does, too.
The fault I assign to Li's otherwise very fine model is that models deal, or at least SHOULD deal, with essentially replaceable markets. An option for 100 shares is, guess what, an option for 100 shares. A $200,000 house's value depends on externalities such as location, features, current local r.e. market strength and quality of construction. Modeling this sort of market is interesting, but likely the end product is not all that valuable in the real world.
As the collateralisers, and especially the subhuman subprimies, have doubtless found out by now, d'accord?
I have no clue as to the amount of CDSes floating around purporting to 'insure' against Greek sovereign debt. The only descriptive I would use is "way the hell too many".
Well I agree with you on the underlying cause of the great recession.
Homes were being used as ATMs. Home “equity” was financing the boom of the early 2000s. I heard economist Chris Thornberg say something like that the amount of mortgage equity withdrawal in California equaled dollar-for-dollar the boom of the 2000s. When house prices stalled the party came to an end.
However, the Lehman failure is when the bomb when off in the banking system. You didn’t see real fear in the investment world until this happened, and it is the event that started the mad scramble for survival in the global banking system.
I’ll grant you that the reasons Lehman failed are rooted in the very problems that you cited, but the Lehman bust was the significant event that brought home the severe problem that a decade of folly had created.
I have a family in Long Beach...Belmont Shores...that just recently sold a home there for close to $800K...Was appraised 10 months ago for over $1.1 million...I think they did good...while the getting was good.
“Surprised to see you mentioned Li. Few outside “rarefied” financial circles have read his work.”
I read a good article on it at Wired:
IIRC correctly Li built his model on one used in the life insurance industry. He may have included a warning that CDO tranches might not behave like actuarial tables. But if he did no one paid attention to his disclaimer, there was just too much eagerness to find some way to price CDOs so that they could easily be marketed. And I believe the over reliance on Li’s model led to the mispricing of risk by the rating agencies.
It’s part of my continuing education in all things housing bubble. I was a housing bubble junkie pretty early on, I’m guessing from around 2004. I live near the epicenter of subprime lending and knew people involved in it.
I have a moderate degree of financial education and knew that there was something seriously hinkey when real estate prices blew past every known pricing model, so I started annoying my friends with predictions of doom. And if you intend to be a prophet of doom you better do your homework because you are going to get bowled over by angry howls of outrage that greet your pronouncements.
And then, when doom indeed arrives, don’t expect to be praised for having been early to the party. The last thing someone with an underwater mortgage wants to hear is you gloating and saying ‘I told you so...’ What they do is get a rope and start looking for a tree limb that won’t break with your carcass added to it.
That’s not too surprising being that it’s Belmont Shores. Prices should hold up like the other wealthy coastal communities, unless TEOTAWKI breaks out in the neighboring ‘hood.
The one negative for Belmont Shores is its proximity to some less than crime-free areas. But you probably get a price break compared to similar property in Newport Beach.
Back in the day....I surfed 56th street Newport.
Friends and I entertained buying a condo down there....We should have!
“Friends and I entertained buying a condo down there....We should have! “
As long as you like crowds. Of course that crowd does bring some excellent scenery.
Regarding size of Greek debt and Greek pension participation in same:
Commentary on Greek debt and pensions Every once in a while, you get a break, eh Dave?
You pop the corn and supply the big screen, I’ll bring the pale ale and single malt. We can kick back and watch the riots when the Greek public realizes what has happened.
The unions over there are going to go positively ape when they figure this out.
Throw in the “oversight” group that will be now installed in Athens to watch over how the Greeks spend money (instead of the audits every quarter) and I’m sure nationalists will really start ramping up the rhetoric too.
I love the “assumptions” that are made in financial and economics papers. They’re hilarious to engineers.
We used to joke in engineering school that we should go into our physics or thermodynamics classes with the types of assumptions made in our economics and business classes. One guy did start out such a question in thermo with “Let’s assume there exists a part of the universe where these ‘laws’ don’t apply.”
The professor looked at him and said “Where, exactly, is this corner of the universe?”
The student said “Same place where the economists live...”
The engineering prof laughed his butt off and said “Please... let’s continue the fairy tale, and then I’ll bring us back to reality later...”
We all had a good laugh about that.
The huge fault I found in Li’s idea was the assumption that there are no conditions which can take down the price of real estate across many or all markets simultaneously. I thought “Well, what about interest rates? Let’s say we go back to Jimmah Carter rates... that’ll put a crimp in most all housing in a fat hurry...”
I also NB that Li has gone back to the PRC. This is very interesting to me: He’s here in North American long enough to publish a paper that is like boob bait for financial bubba’s, they load up our capital markets with assumptions based on a theory too good to be true... and then he splits.
Would have been just an investment.....