Another Plan Backfires?

The ECB has been urged from all sides to contribute to the Greek debt 'haircut'. After all, so it was rightly argued, the central bank bought these bonds at a big discount to par, and so would not suffer any losses if this discount were passed on to Greece.

The problem was mainly a legal fine point: the ECB is not allowed to 'finance governments' directly, and so a method had to be found to circumvent this prohibition. As was already intimated by the central bank a little while ago, the legal maneuver to be employed was to distribute the 'gains' from the ECB's Greek bond holdings to euro area member nations, which then could decide themselves what they wanted to do with the funds. 

The practical implementation involves a swap of the old bonds for new ones that are priced at par. Thus the difference can be booked as a profit, which the ECB then can distribute.

Alas, this still means that current owners of Greek debt will end up as subordinated creditors, as the new bonds will exempt the ECB from collective action clauses. And there lies the rub. This is why we noted above that 'yet another plan backfires'.

However, a potential side benefit seems to be that CDS on Greek debt may be triggered, as Greece is now free to retroactively insert collective action clauses regarding the bonds held by private investors. This will ensure that the market for CDS on sovereign debtors remains viable.

As Bloomberg reports:


“The European Central Bank’s plan to shield its Greek bond holdings from a restructuring may hurt private investors while paving the way for debt insurance contracts to be triggered.

The ECB will exchange its Greek debt for new bonds with an identical structure and nominal value, though they’ll be exempt from so-called collective action clauses the government is reportedly planning. That implies senior status for the ECB over other investors, according to UBS AG, and the use of CACs may lead to credit-default swaps protecting $3.2 billion of Greek bonds being tripped.

“It may appear that the ECB is receiving preferential treatment, raising questions about whether the ECB is senior to private-sector bondholders,” according to Chris Walker, a foreign exchange strategist at UBS, the world’s third-biggest currency trader. “If a coercive default does indeed eventually take place then a CDS event seems very likely with all the negative consequences for risk appetite that may bring.”

Government officials are separately negotiating a writedown of the nation’s debts with private investors before a 14.5 billion-euro ($19 billion) note comes due on March 20 that risks sending Greece into default. The yield on the nation’s benchmark 10-year bond jumped 28 basis points today to 33.67 percent as of 1:30 p.m. in London, its sixth straight day of increases.”


(emphasis added)

Well, we agree that the fact that all other creditors will end up subordinated to the ECB is a big negative. However, we completely disagree with UBS that a triggering of the CDS will also represent a negative factor and have 'negative consequences for risk appetite'. The exact opposite is true. If CDS are validated as a viable means of protecting against sovereign defaults, risk appetite will increase, not decline. We rather suspect that this is a self-serving analysis by UBS (it may be that it is a writer of CDS on Greece, although we can of course not ascertain that).

In fact, Art Cashin mused yesterday that the biggest danger emanating from the PSI deal was that the CDS may not be triggered (ironically, Cashin also works for UBS):


“Now traders fear the issue will come back again with a vengeance.  The [finance] ministers do not want to see a lot of CDS contracts triggered since they don’t know who owns them or, more importantly, who wrote them. That could become a domino-like contagion ala 2008.

But, traders fear a worse outcome might occur if the CDS contracts do not kick in. What good is insurance that doesn’t pay off.  That could lead to the assumption that all CDS insurance was useless. That would stratify debt around the globe.  Great credits could get all the money they wanted, but less than great credit would be shut out because it could not be insured. That could make the future one in which “the haves” will have whatever they want and all others nothing.  Welcome back to the Middle Ages.”


(emphasis added)

Cashing is exactly right in our opinion. In fact, the remaining €2.8 billion in CDS on Greek debt are not even a drop in the ocean compared to the total outstanding debt load of € 360 billion. There is no reason whatsoever to worry about the effect of these contracts triggering.

As regards subordination of creditors to the ECB, there is of course a potential contagion effect that may strike.

The Bloomberg article continues:


Subordination of other bondholders behind the central bank is a problem “not only in the case of Greek debt, but also regarding the debt of other euro-zone nations that the ECB may be purchasing,” London-based Walker wrote in a report. The ECB’s plan “will likely lead to euro weakness,” he wrote. Still, it’s “a sign of progress toward an eventual Greek debt restructuring.”


(emphasis added)

The entire SMP (the ECB's bond market manipulation program) may turn out to be a completely self-defeating exercise in futility.


Chart Updates

Below is our customary collection of charts,  updating the usual suspects: CDS on various sovereign debtors, bond yields, euro basis swaps and a few other charts. Charts and price scales are color coded (readers should keep the different scales in mind when assessing 4-in-1 charts). Prices are as of Thursday's close.



5 year CDS on Portugal, Italy, Greece and Spain – the recent move higher in CDS on Greece continue for now – click chart for better resolution.



5 year CDS on France, Belgium, Ireland and Japan – click chart for better resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – click chart for better resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – the latter two seem poised for a breakout to new highs – click chart for better resolution.



5 year CDS on Romania, Poland,  Ukraine and Estonia. We have a feeling the Ukraine will produce a few headlines in as the year progresses – click chart for better resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – CDS on Saudi Arabia are suddenly on the move again. This is a situation well worth keeping an eye on – click chart for better resolution.



5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns. We think we will see new highs in the SovX sometime this year as well – click chart for better resolution.



Three month, one year, three year and five year euro basis swaps – the rebound has stalled out. This is a potential negative for gold, as it makes shorting gold very cheap (lease rates turn negative when the GOFO rate is above LIBOR) – click chart for better resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito)  –  a slight dip – click chart for better resolution.



5 year CDS on two big Austrian banks, Erstebank and Raiffeisen – the rebound in these continues – click chart for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain. Portugal's yields  have given back the recent 'panic spike', but we will certainly hear from Portugal again soon – click chart for better resolution.



UK gilts, Austria's 10 year government bond yield, Ireland's 9 year government bond yield and the Greek 2 year note – the Greek two yea note at a new record high yield of over 212%. This is not good – click chart for better resolution.



Australia's Housing Bubble In Trouble?



5 year CDS on Australia's 'Big Four' banks.  A very strong rise yesterday. There are rumors that these banks are now getting into trouble over Australia's mortgage credit bubble. Prime minister Julia Gillard has reportedly been 'urged to follow Ben Bernanke's example' and see to it that mortgage backed securities are bought up by the government in order to support the tottering credit bubble – click chart for better resolution.



From Bloomberg we learn that Australia's lenders are now whining rather insistently about needing more government help:


Australia’s Prime Minister Julia Gillard may be forced to follow U.S. Federal Reserve Chairman Ben S. Bernanke by increasing mortgage purchases as house prices slump and the nation’s biggest banks extend their grip on the home-loan market.

Non-bank lenders including Greater Building Society and CUA say more government purchases of residential mortgage-backed securities will be needed as Europe’s debt crisis saps investors’ appetite for risky assets. The Australian Office of Financial Management has spent 73 percent of the A$20 billion ($21.4 billion) allocated to keep smaller lenders competitive after the credit freeze following Lehman Brothers Holdings Inc.’s collapse in 2008.

Australia’s four biggest banks have increased their share of outstanding mortgages to 86 percent as of the end of last year, up from 75 percent when the program started, according to regulatory data. Mortgage costs are a sensitive issue for Gillard as her Labor party prepares to face voters by the end of next year in a nation that has the second-least affordable homes behind Hong Kong and nine out of 10 borrowers pay variable interest rates.

“If the federal government is serious about supporting competition in the Australian home-loan market, the AOFM will need more cash,” said Greg Taylor, chief financial officer of Greater Building Society, the Newcastle-based lender that was founded in 1945. “Our cost of funding is higher than the major banks but we have been absorbing this to still offer products and services that are competitive. This practice is becoming increasingly challenging.”


(emphasis addded)

So this is dressed up as a plea to keep the Australian mortgage market 'competitive' via government intervention. In reality, they are probably scared to death that the housing bubble will collapse just as has happened elsewhere.


Charts by: Bloomberg



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