Greek PSI Deal Deadline Approaches

On Thursday Greece will have to decide whether or not to retroactively include collective action clauses into the contracts governing its debt. The ECB already let it be known over the weekend that it doesn't expect the participation target required to avoid this step to be reached.


“The European Central Bank expects that the participation rate of Greece’s private creditors in the planned voluntary debt restructuring deal will be too low and collective-action clauses will have to be invoked, a person at the central bank told German weekly magazine Der Spiegel.

Greece has agreed on a debt restructuring with the private sector, which is a precondition for the second bailout package worth EUR130 billion. As part of the offer to private-sector investors that expires Thursday, these investors will have to take a 53.5% loss on their principal and will swap their old Greek bonds with new bonds that have longer maturities and lower coupons. Greece faces a EUR14.4 billion bond redemption on March 20 and needs to tie up external assistance because it doesn’t have enough funds to make the bond payments.

“The retroactive collactive-action clauses will likely have to be applied,” the person told the

 magazine, according to a prereleased report of its Monday edition. Greece has already approved a law on collective-action clauses, or CACs, are provisions that bind all bondholders to take part in a debt exchange if a predetermined majority approves of the exchange.

If Greece does use the CACs, such strong-arming would be a clear trigger of CDS payouts under definitions governing the contracts, market participants say. Given the focus of European policy makers on avoiding triggering CDS, some in the markets worry that some entity might be on the hook for more CDS payouts than they can handle .”


(emphasis added)


Credit Event?

The 'netted' exposure to CDS on Greece is only $3.2 billion, which seems to be an amount the market should be able to handle easily. However, the gross notional amount is nearly $72 billion – and one's netting is only as good as one's counterparties. It can therefore not be ruled out that there will be some trouble if the CDS payments are triggered, although we don't expect so at this point in time. As it were, writers of CDS have to put up collateral to cover the bulk of their exposure. In recent days the demands for more margin collateral must already have soared given the big move in CDS on Greek debt.

Charles Dallara of the IIF has meanwhile said that he thinks the 'debt exchange will succeed', which may have led to Greek CDS falling prey to a little bit of profit taking on Monday and yesterday. Alas, Greece was forced to officially deny that it will have to move the deadline for the PSI deal on the very same day.

It seems quite evident though that the market expects a credit event to be declared and the CDS payout to be triggered.


Tough Talk

An amusing read in the context of Greece's impending non-default default is this paper by the IIF that discusses the possibility of a 'disorderly' default. This was presented as a means to exert pressure on holdouts, but it is nonetheless an interesting read  (just take it with a big grain of salt). According to the IIF, a 'disorderly default' and exit from the euro area by Greece could cost up to € 1 trillion, not primarily due to the losses that would be incurred immediately, but mainly due to the inevitable contagion effects (more on this further below).

Obviously, the IIF is exaggerating the putative 'worst case' scenario as much as is possible – this is evidently part of the last minute 'tough talk' campaign it and the Greek government are now busy with.

The Greek ministry of finance has also issued blustering threats that are formulated in a manner that seems to be indicating 'participate or you'll get nothing':


“The Republic’s representative noted that Greece’s economic programme does not contemplate the availability of funds to make payments to private sector creditors that decline to participate in PSI.  Finally, the Republic’s representative noted that if PSI is not successfully completed, the official sector will not finance Greece’s economic programme and Greece will need to restructure its debt (including guaranteed bonds governed by Greek law) on different terms that will not include co-financing, the delivery of EFSF notes, GDP-linked securities or the submission to English law.”


However, as Reuters informs us, all the threats and cajoling won't be enough to persuade the most strongly committed holdouts (which is nearly everyone who's not a bank or institution that can be coerced by its government or alternatively has written a ton of CDS on Greek debt and/or both. Naturally holders of the CDS will refuse to take part).


A number of the biggest bondholders are signing up but despite the dire warnings, a clutch of Greek pension funds and some foreign investors rejected the offer which will see investors lose almost three-quarters of the value of their holdings and lop about 100 billion euros off Greece's debt.

Athens ratcheted up the pressure, delivering its starkest signal to date that it will force losses on those who do not volunteer.

Its Debt Management Agency (PDMA) said if it got enough support, it intended to make losses "binding on all holders of these bonds" and said the offer was the best deal they would get, echoing comments by Finance Minister Evangelos Venizelos to Reuters on Monday.”


(emphasis added)

Reuters then comments on the scarecrow the IIF has put up, which is about as transparent as the Bush and Blair administrations' propaganda efforts when they were drumming up support for the invasion of Iraq in 2003 (in other words, it is such obvious 'let's scare them with goblins' garbage it is downright embarrassing) – we have interspersed a few comments:


“Analysts said an Institute of International Finance document, marked "IIF Staff Note: Confidential", seemed designed to alarm investors into participating in the exchange by estimating the extent of havoc a disorderly default would wreak.

"It is difficult to add all these contingent liabilities up with any degree of precision, although it is hard to see how they would not exceed 1 trillion euros," the IIF, which represented private creditors in months of tortuous debt negotiations with Athens, said in the February 18 document obtained by Reuters. [enter the fear strings! ed.]

If Greece misses the March 20 payment without a deal in place and succumbs to a hard default, it could be taken as a sign that politicians have lost control of the crisis again, prompting investors to target other weak euro zone countries. [oh, they have it 'under control' now? Thanks for letting us in on this! ed.]

Spain and Italy might require 350 billion euros in outside support to contain the fallout, the IIF said, while the cost of helping Ireland and Portugal could total 380 billion euros over five years. [even louder fear strings! ed.]

"When combined with the strong likelihood that a disorderly Greek default would lead to the hurried exit of Greece from the euro area, this financial shock to the ECB could raise significant stability issues about the monetary union," it said. [that would be a shame, considering that it is otherwise stable as a rock, ed.]

The bank lobby group also said bank recapitalization costs could easily hit 160 billion euros if no swap is agreed. "Obviously the report is written on a worst-case basis to try and encourage participation in the exchange," said Gary Jenkins, analyst at Swordfish Research. [you don't say! ed.]


Although more and more bondholders have in recent days announced their support of the deal, he crux of the whole exercise remains the following:


“Investors in a Swiss-law governed Greek government bond have teamed up to challenge the terms of Athens' proposed bond swap, highlighting the wave of litigation it could yet face, particularly over the minority of its debt not issued under Greek law.

Greece wants a take-up of 90 percent or more, and if it falls below that but exceeds 75 percent it is expected to use collective action clauses (CACs) to force losses on all. It could trigger CACs on Greek law bonds, which account for 177 billion euros of the total, with two-thirds acceptance. Below that level, the deal could be off, potentially plunging the euro zone back into crisis.

The Greek finance ministry denied speculation that it was planning to extend the deadline on the offer, highlighting the jittery mood just two days before final decisions are due.

"The most likely outcome may well be that Greece passes its 75 percent target and then uses CACs to ensnare the remainder," Jenkins said.


We would tend to agree with the above quoted Mr. Jenkins about the 'most likely outcome', but note that there remains a small risk that the entire deal could still blow up. Now that would be quite the show. Does anyone think that's 'priced in'?  As an aside to this, even four Greek pension funds have refused to take part in the debt swap.


The Sick Child with the Big Debt in Calmer Waters

In addition,  an investor protection group in Germany has advised its members to reject the deal, and we are pretty certain that quite a few hedge funds will also hold out. Hence we will likely soon learn whether the payout of the CDS can be handled without creating a disruption (in other words, collective action clauses are likely to trigger the CDS).


Germany’s DSW investor protection group advised private sector bondholders to reject the Greek bond offer, according to an e-mailed statement today.

Leaders of the EU last week said their focus will shift away from budget-cutting to growth measures after completing the details of a second Greek bailout package. Whether that 130 billion-euro package can proceed will depend on the outcome of this week’s swap.


Alas, the eurocrats are busy dispensing bromides. We're in 'calmer waters' now, and Greece is nothing but a 'sick child':

As Bloomberg reports further:


“We’re in calmer waters,” EU President Herman Van Rompuy said in an interview on Dutch television’s “Buitenhof” program yesterday.

EU leaders have called Greece’s case unique while vowing to keep the country where the debt crisis originated in the monetary union.

“If you have a sick child in the family, you don’t abandon it, but work on a remedy,” Austrian Finance Minister Maria Fekter said in a March 3 radio interview with state broadcaster ORF. “That’s what we’re currently trying to do with Greece.”

The Institute of International Finance, which represented private creditors in the negotiations over Greece’s debt swap, yesterday endorsed the final terms of the deal and left it up to its members to choose whether to take part.”


Someone should perhaps remind Herman van Rompuy that we are in 'calmer waters' only temporarily, due to a € 1 trillion injection of LTRO funds by the ECB. Admittedly, Spain's and Italy's bond yields have declined at impressive speed ever since, exceeding even our expectations, but as far as we can tell no fundamental change has actually occurred.

As to Mrs. Fekter's description of Greece as a 'sick child', you don't often get to know a sick child that owes you €360 billion. We would wager that this is rare even in extended families.



Herman van Rompuy: 'calmer waters'. Has anyone else noticed that he always looks like he's stoned? Maybe he is.

(Photo via )



Austrian finance minister Maria Fekter: Greece a 'sick child'. We could think of a few  comebacks for the Greeks, which shall remain unmentioned (use your imagination).

(Photo via )



As to the danger that the whole deal could still unravel, it has increased immensely just yesterday due to positive comments uttered by the EU's chief contrary indicator Olli Rehn:


“The cancellation of a large chunk of Greece's debt should take place "without a hitch", the EU'sEconomic Affairs Commissioner Olli Rehn told French newspaper Le Figaro on Wednesday. [uh-oh! ed.]

"According to our information, the debt swap should take place without a hitch since the operation is interesting financially for the private sector," Rehn said in the interview.
The commissioner was asked about the possibility that holders of default insurance policies, known as credit default swaps, would claim payment if the Greek swap offer went badly.

"It is not a scenario that we are privileging. Quite the opposite," he said, a day after fears on the debt swap sent global stock markets down sharply.

Market investors are hoping enough of Athens' private creditors sign up for the debt swap — essentially a 107-billion-euro ($140-billion) writedown of their bonds.

The plan's success is a key condition for a 130-billion-euro rescue package to save Greece from a debt default and avoid another potential global crisis.

Rehn said the "risk of explosion (of the eurozone) is behind us" [this deserves an even bigger uh-oh, ed.], but recession in the eurozone was here "and unemployment was worrying".


(emphasis added)

Oh, so 'we' are not 'privileging' a scenario that would imply that contracts between private parties trying to insure themselves against the antics of a profligate political class are actually worth the paper they're written on.

Who would have thought! Of course this is not up to Rehn, but the ISDA, but it is noteworthy that his hubris appears undiminished. Apparently no-one in the eurocracy got the memo yet: as soon as it becomes clear that CDS on sovereign debt are not a viable hedging instrument, there is only one course left for the holders of bonds issued by 'PIIGS' governments, plus Belgium and a few others (not the least of which is probably France): Sell!



Olli Rehn: that's how much you'll get, and not a cent more.

(Photo credit: AP)



Lastly, whenever Rehn tells you that nothing can go wrong, chances are that everything will. Better be safe and batten down the hatches.


Credit Market Charts

Below is our customary collection of charts,  updating the usual suspects: CDS on various sovereign debtors and banks, 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 Tuesday's close.  As noted above, there was a little bit of profit taking in CDS on Greece on Monday, but they bounced again yesterday. CDS on Portugal keep creeping higher once again.

We also saw bounces beginning elsewhere in sovereign CDS land, a case of bargain hunting it appears to us. Recently falling sovereign bond yields have turned up again as well. Maybe the waters will turn a bit less calm now.



5 year CDS on Portugal, Italy, Greece and Spain – click chart for better resolution.



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



5 year CDS on Romania, Poland,  the Ukraine and Estonia – click chart for better resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – click chart for better resolution.



5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns – note that the SovX remains elevated and is moving back toward its highs – click chart for better resolution.



Three month, one year, three year and five year euro basis swaps.  Looking a tad better again – 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) – ticking up again on over the past two days. Note this is the first close above the 34 dma in quite some time – click chart for better resolution.



5 year CDS on two big Austrian banks, Erste Bank and Raiffeisen Bank – still looking OK, but also ticking up on Tuesday – click chart for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – a few more small upticks here – 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 – not much going on in these at the moment, except that the Greek 2 year note yield has reached another all time high at nearly 260% – click chart for better resolution.



5 year CDS on Australia's 'Big Four' banks –  a slight move in the 'risk off' direction. One of them is suddenly catching a bid apparently – unless it turns out to be a short term aberration, we will endeavor to find out if there's a specific reason for this – click chart for better resolution.



Addendum: The Stock Market Correction

It seems that the increasingly likely stock market correction we spoke about on Monday has  indeed begun. As we have pointed out, very often the 'first dip' will end up getting bought –  the first big decline is usually just a 'warning shot'.

However, one can never be certain of how precisely the cookie will crumble. We will keep a close eye on how sentiment related and technical data evolve in reaction to this swoon and will keep our readers posted on what develops.

In the meantime, the WSJ has also noticed that insiders have been selling their stocks hand over fist, something we have discussed here over five weeks ago.

Also noteworthy in this context: John Hussman's latest weekly missive – he has penned  A New Who's Who of Awful Times to Invest, reminding us that the current time definitely belongs to those rare moments when buying stocks is almost certain to turn out to be a grave mistake.



The SPX has its first bad hair day in a long time. It probably isn't yet the beginning of a big correction, but it is a warning shot: a reminder that the market is not a one way street. Given the vast bullish consensus, we are inclined to take the warning seriously – click chart for better resolution.





Charts by: Bloomberg, StockCharts


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2 Responses to “Debt Swap Deadline for ‘Sick Child’ Nears, Plus Credit Market Watch”

  • 22945. That is the premium on Greek CDS’s. Now, i am wondering who is on the hook for $3 billion and how $72 billion got to $3 billion? I understand buying and selling, like a SPX futures, but there is a clearing house and the losses or gains are already accounted. It appears there is $72 billion in actual risk out there, thus someone is going to pay and someone is going to collect this amount.

    This bring us to why they wouldn’t pay a loss that was pushed on the market? Unless I am mistaken, CDS’s pay the entire security minus recovery, which in this case would be 75%. A 50% haircut is a 50% loss. There are 2 components i can see, the agreed risk fee and the term. The term is important here, as we are now in 2012. What is important about 2012 is that 2007 was before everything blew up and CDS’s were used more to transfer portions of portfolios or enhance return in theory than to bet on failure or success of a particular risk. The premiums were cheap, but the risk runs out in 2012. How much of this delay has to do with the expiration of the risks? Looks like dirty pool to me.

    I posted the premium because this in itself says a lot. It says that some parties are betting we have a fast default. But, I am assuming premium is earned to the day of default and if you figure the loss is going to be 75%, the premium makes money for the insurer if the term can be pushed out 4 months. In fact, if they can push it out 8 months, the seller of risk makes twice what they pay out. Thus we can go day to day with Greece on the edge of the abyss and these swaps and their returns are affected greatly. Old securities expire, meaning the people that made the mistakes keep their money and the premiums as well, while those who bought protection are holding the bag. In the shorter term, those that sold at high premiums are having their losses decrease by the day while those that bought are seeing gains turn into losses. Some could lose double. 120 days! This means that every 3 days that pass, 2.5% of the loss is earned by the seller of risk and paid by buyer. When you add the primary players on the risk are the voters of declaring a default, looks to me like they have a rigged game.

  • rodney:

    Now, now, Pater, naughty boy: Making fun of those hard working eurocrats trying to save the world!!

    Very funny and enjoyable, thank you!

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