Talk of widespread haircuts getting more serious. As previously discussed, this has the potential for catastrophic global financial meltdown.

Analysis: Greek default may be gift to other euro strugglers

By Mike Dolan

Mar 7 (Reuters) — Greece’s tortuous debt restructuring and threat of retroactive laws to compel reluctant creditors heaps regulatory risk onto investors but may make voluntary sovereign debt revamps more attractive and likely for other cash-strapped euro sovereigns and their creditors.

Thursday could mark a climax of the Greek debt workout with private creditors due to respond to an offer that would see them effectively write off more than 70 percent of the face value of their bonds in return for new debt with a series of sweeteners.

With Greek government bonds currently trading at less than 20 cents in the euro and the risk of a total wipeout if Greece decided to unilaterally refuse all payments, a majority will likely go for it. Legally-binding majorities are another matter.

Athens said this week it aims for 90 percent acceptance but if the takeup is at least 75 percent then it would consider triggering so-called “collective action clauses” retroactively inserted into the bonds issued under Greek law — about 85 percent of the 200 billion euros being restructured.

Those clauses in practice force all affected creditors to comply.

But it’s this distinction between debt issued under domestic laws and that sold under internationally-accepted English law that some say has consequences for other troubled euro nations eyeing Greece’s so-called Private Sector Involvement, or PSI.


In essence, English-law Greek bonds, as is the case for many emerging market sovereigns, trade as if they were senior to local-law debt — at almost twice the price in fact right now. That’s because the terms of foreign-law bonds cannot be altered by an Athens parliament, and agreement for debt swaps is needed bond-by-bond, unlike local laws that aggregate majorities across all debtors and make blocking minorities more difficult to muster.

A paper released this week by Jeromin Zettelmeyer, deputy chief economist at the European Bank for Reconstruction and Development, and Duke University Professor Mitu Gulati reckons this legal gulf could well encourage other debt-hobbled euro zone countries and their creditors into mutually acceptable and beneficial debt restructurings.

This would involve an agreed switch in the legal status of the debt in return for relatively modest haircuts.

“Holders of local-law governed bonds in other euro zone countries that are perceived to be at risk might want to make a trade for English-law governed bonds,” the economists wrote. “Depending on how much these bondholders would be willing to pay to make this trade, it could serve the interest of the country as well to make it.”

The sovereign gets a chance to reduce a crippling debt burden while bondholders get greater contractual protection in any future restructuring.

Given that the Greek precedent of retroactive legislation vastly increases the allure of foreign-law bonds, which credit rating firm Moody’s says now make up less than 10 percent of all euro zone government bonds, a window of opportunity may open up.

“Effectively, this is a large gift from the Greeks to the parts of the euro zone that face debt crises. By conducting its debt exchange in the way it did, Greece has in effect resurrected the plausibility of purely voluntary debt-reduction operations in Europe.”

Although Berlin, Paris and Brussels insist the Greek case is a one-off and European Central Bank liquidity has insulated the wider banking system, Portugal’s 10-year bonds still trade as low as 50 cents in the euro and many creditors reckon it will be very difficult for the country to avoid some restructuring.

Even the 10-year debt of fellow bailout recipient Ireland, which many investors reckon has the underlying economic capacity to go back to the markets next year, is still trading at less than 90 cents in the euro and many doubt its imminent market return.

“We still expect a sizeable growth undershoot and deficit overshoot and expect that Ireland will need a second financing package (which may include PSI) beyond 2013,” economists at Citi said on Monday.

What’s more, if Europe’s new fiscal pact is rejected by voters in a planned referendum there in the coming months, Ireland would lose access to the financial backstop of the European Stability Mechanism and likely unnerve many investors.

Yet voluntary debt swaps with some debt relief stemming from more modest haircuts than Greece may well be the best way to ensure these two countries avoid outright default and return to private financing in a reasonable amount of time.

And if such exchanges were wholly voluntary, it would also mean credit default swap insurance would not pay out — a stated aim for many euro policymakers concerned about the speculative nature of a market where it’s possible to buy insurance on something you don’t own.

One danger is that the prospect of countries opting for such a swap may scare creditors in larger countries like Italy and Spain where currently no bond haircut is expected by the market, thanks in large part to the ECB’s liquidity injections.

And the upshot for many economists is that there will be a longer-term price to pay for governments for tinkering with the rules of the game, as many investors view it, via the likes of retroactive bond legislation and obfuscation of CDS markets.

“Investors will expect a premium for bearing this regulatory risk,” Morgan Stanley’s Manoj Pradhan told clients in a note, adding that only central bank liquidity floods were now obscuring the resultant higher financing costs and there would be a dangerous blurring of lines between macro and market risks.

But given that indiscriminate cheap lending was seen as at least partly responsible for the credit binge and bust of the past five years, maybe higher risk premia are not all bad.

7 Responses

  1. “catastrophic global financial meltdown” Thems strong words Warren, I can’t imagine the warren I met on the old board ever even THINKING that possibility, much less uttering it, much less in public, your journey is almost complete, the rosy colored glasses are starting to fog a little. Just think, those 99% useless financial people that are doing things on 6 or 7 abstractions away from reality will no longer be needed in that post-financial meltdown world and can be reapplied to more useful or personally creative endeavors. A new age for mankind, post modern finance.

    In celebration of IBM’s Computer taking over at citi,

    Unemployment is high, labor mobility is low, most people just don’t have the skills or intelligence to do higher order work like genetic research or algorithm design, can’t take an old dog like Warren and turn him into a bioscience genius. The way our entire system is structured is very flawed, the few geniuses or crooks at the top will get most of the capital, and the 99% below are just here by the grace of the robots.

    Time to start telling the 99% its OK if all you can basically do is surf the internet and watch catz videos, don’t stress that you can’t understand how your own brain works at the quantum level. Be happy you can get food stamps and free government housing.

    Warren, its time for you to start using your pulpit to tell the masses what to do in a post financial collapse world, post oil peak world, 6 billion can revolt and war and kill, or they can accept that the “machines” have made john henry obsolote in this new world, but thats OK, a lifetime spent watching youtube all day and reading MMT blogs isn’t so bad is it?

      1. @roger erickson, There’s plenty of demand,but not from computers.. The problem is it’s not effective demand as it has no purchasing power.A job guarantee would help,but as time goes on,more and more of the needed work will be done by computers and automation. We need to reduce working hours and get people conditioned to more leisure.

    1. @Save America, There’s more to life than work or watching videos,or reading and commenting on MMT blogs. Music,arts,research and development,the things the wealthy do as they don’t need to spend every waking minute earning to get the basics.

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