The Greek Restructuring Debate

Cross-posted with Credit Writedowns

Yesterday I was on BNN’s Headline with Philip Coggan of the Economist and presenter Howard Green. The issue of greatest importance that we discussed yesterday was Greece.

Last week, German Finance Minister Wolfgang Schaeuble indicated readiness to accept a soft restructuring and bond exchange which would defer interest payments on Greek sovereign debt. He sent a letter to colleagues in the euro countries indicating this. However, since that time, central bankers have expressed disquiet over this policy approach. Yesterday, ahead of our chat, Mario Draghi, the head of the Italian central bank and likely next European central bank head, rejected this idea in very strong language saying, explaining that “the ECB is not in favour or restructuring and haircuts” and that it “excludes all concepts that are not purely voluntary.”

For now then, it seems a soft restructuring is off the table. Nevertheless, market participants are uniform in their belief that Greece will restructure. And Greek bond yields have soared on the back of this expectation. Moreover, contagion has seen all of the euro zone periphery suffer with CDS and yields increasing in Spain, Portugal, Ireland and Italy. This is clearly unsustainable and I expect a definitive policy response in the next few days.

As a reminder, I posed the question “Can Greece CDS Trigger A European Lehman?”, answering yes and acknowledging the fears that Draghi and other central bankers have about a restructuring. Nevertheless, it is clear that the ECB and the other euro zone national central banks are not impartial due to their exposure to peripheral bonds and the potential for a loss of capital in the case of a euro zone sovereign default. The ECB is not conducting a stealth bailout through the euro zone Target2 payment system. However, national central banks do face a potential loss of capital based on their share of ECB capital and this creates a conflict of interest that makes the euro zone sovereign debt crisis even more tricky.

Europe needs to make a choice of a temporary bailout or immediate restructuring now because the backdrop to the Greek drama is worsening.

  1. Some Greek socialist MPs are defecting away from the planned austerity backed by the Greek government. There is a risk that the austerity plan will be rejected. As I write this, Greek workers are striking, with a major confrontation developing in the Syntagma Plaza. The situation is very bad with tear gas, Molotov cocktails, the whole nine yards. One financial journalist, Stacy Herbert, for example, has provided live commentary on twitter. This is a clear indication that austerity will be resisted in Greece and that a restructuring is inevitable.
  2. Contagion continues to spread. The Greek 2-year is yielding over 27% now. Not only are we seeing a selloff in peripheral CDS and bonds, we are also seeing downgrades on multiple fronts. S&P recently downgraded Greece to the world’s lowest sovereign credit rating at CCC, below Pakistan and Ecuador. A raft of Greek bank downgrades by S&P followed since they will be capital-impaired due to a Greek default. And a set of French bank downgrades (BNP Paribas, SocGen and Credit Agricole) by Moody’s also followed as these banks have heavy exposure to Greece. And there is always the opaque CDS market.

While I acknowledge the real fears that central bankers have about the impact of a restructuring, this political dithering is making matters considerably worse. Clearly, burden sharing is needed and that means bondholders will have to take haircuts. Like the Greek government, the Irish government, under pressure from central bankers and Timothy Geithner, has heaped all of the burden onto taxpayers (pointer to Kevin O’Rourke). This should not and cannot last.

(Click on the image of Howard Green below for the BNN videos. We also discussed US monetary policy and China.)

Howard Green

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Pat

    The Greek debt crisis is an international game, not just a European one. Apparently American banks are on the hook for $100 billion if the Greek CDSs are triggered through default or involuntary restructuring.
    So that is probably why the recent proposal for “voluntary” restructuring (except for ECB bonds) with no triggering of CDSs is so appealing. The American banks take no loss. The “speculators” holding Greek bonds take a haircut and get no windfall from their CDSs. These speculators probably include mostly private investors like hedge funds and perhaps a fair number of French and German banks. The ECB takes no loss, at least not yet.
    The Germans clearly have the most to lose if Greece defaults and the Eurozone collapses, so they would favor a plan that keeps the Eurozone intact for as long as possible.
    Apparently (according to Zero Hedge) a large amount of the recent $600 billion QE2 went to foreign banks with branches in the US. I imagine that the Americans thus have some leverage over the European banks and they would side with the Germans in forcing bondholders to accept this “voluntary” restructuring. The US knows that it is in their best interest to support Germany and to let the losses fall, as far as possible, on everyone else.
    So for this reason I expect the German plans will prevail, whatever they may be. The French and Italians are just making a lot of noise.

    1. David

      How does the U.S. government permit banks to be on the hook for $100 billion of CDS if Greece or Ireland defaults. Basically, these numbskulls have sold insurance on contingencies that they cannot cover, the same nonsense that AIG pulled.

      The main question is-Why the heck does the U.S. government even permit its banks to offer credit default swaps after the lessons of 2008?

      1. Daniel Pennell

        Because banks have strong political influence and they are desperate for yields and profits.

      2. MLS

        I’m willing to bet that many of those CDS were in place long before 2008, and sovereign risk is very different from corporate or mortgage risk.

        Not excusing the activity, I just don’t think comparing this situation to CDS on MBS in 2006 is valid.

        1. David

          In order to sell an insurance product, you have to a very good idea of the probability of an event. How the heck does any reasonable person assume that they can calculate the probability of a sovereign debt default in 5 or 10 years? And, I really doubt that all these swaps are pre-2008. And, why didn’t the insurer just buy them back at some point.

          1. MLS

            CDS are written based on estimates of the probability of default of the issuer. That’s why CDS on corporates are wider than on sovereign. The assumptions of default can be done the same way a credit rating agency does it – throw a bunch of budget and growth numbers into a model and it gives you a rating or a spread (let’s overlook the seedy nature of the rating agencies for now). In the case of most sovereigns, they can always print more money or raise taxes or cut spending to stave off default, so they receive higher ratings. It is fair to question whether the downside to Greece’s membership in the EU (lack of an independent monetary policy) was considered strongly enough.

            I didn’t say all the CDS were pre-2008, but certainly some of them are. I submit that it’s a significant majority because these things were written like crazy in the early/mid 2000s. An issuer can’t necessarily buy them back because 1) they like the income from the premiums and 2) the owner is hedging a risk and doesn’t want the exposure without protection.

      3. Cedric Regula

        It’s because the USG knows that banks know what they are doing.

        hahaha. I was making a joke.

        Good news is the world is getting around to defining what a “credit event” is. Then we’ll know what the hell it is that triggers a CDS payout. Another risk factor, but these boys are in the game for risk!

        I’m still wondering if your Czechoslovakia CDS did a two for one split, and if that’s a good thing or not?

        Is your Soviet Union CDS a turn around play, and would Hungarian CDS be a takeover CDS?

        These guys have to keep from getting bored somehow.

      4. Yves Smith

        The amount of CDS outstanding on Greek sovereign debt is bupkis, only 2% of face. It is much more important as a precedent, it will spike the spreads on other peripheral country debt.

    2. Cedric Regula

      Kash Mansori has been analyzing the BIS data on US bank exposure. The $100B figure is greece, ireland and portugal, summed.

      Also, I’m a zero hedge fan, but the thing about QE2 going to foreign bank branches I think is overdone.

      For one thing, calling places like Deutchbank and Credit Swiss US operations a “branch” is a huge understatement. That would make 97% of US banks twigs.

      Then in QE2 the Fed paid money (and we know how they do that) for treasury inventory held by what is now 20 primary dealers. I’m too lazy right now to try and find the list of primary dealers on the web, but I’m nearly certain a few are “foreign” banks.

      So I think this is what ZH must be talking about, but there is nothing that surprising about it.

      Other than QE should be banned by Constitutional Ammendment, period, because it looks like something they didn’t think about when they wrote the Federal Reserve Act, and if the Fed can grow its balance sheet until it pops, that would not be in the spirit of the law, I don’t think.

      1. James Cole

        A lot of the money that went from Fed to Dexia came back via the US bond insurer FSA, which Dexia owned, and when the sh!t hit the fan, Dexia put a lot of capital behind FSA to keep it viable as a muni bond insurer.

  2. Fear N Loathing

    Athens, Greece (CNN) — Greek anti-government protests turned violent Wednesday, as protesters threw petrol bombs at the Ministry of Finance and police fired tear gas at protesters, police said.

  3. Jim Haygood

    ‘The ECB and the other euro zone national central banks are not impartial due to their exposure to peripheral bonds and the potential for a loss of capital in the case of a euro zone sovereign default.’

    Indeed not. Like Lehman, central banks including the ECB and the Federal Reserve are heavily leveraged. With honest accounting, the capital hit from a Greek restructuring could leave them with negative net worth. The question is, what then?

    One IMF paper claimed that nothing happens — life goes on. The reason is that a central bank’s principal liabilities — banknotes — are not redeemable. If you ‘redeem’ a dollar bill at the Federal Reserve, all that you’ll get back is another dollar bill. You can’t redeem it into gold, silver, or even a chunk of the debt instruments which nominally ‘back’ it. Absent redemption, a run on the central bank is not possible. It can go on operating while insolvent. In fact, if their assets were marked to market, the ECB and Federal Reserve probably ARE insolvent already.

    However, a devaluing of an insolvent institution’s liabilities — that is, a devaluation relative to other currencies — is certainly possible. More likely, though, is that rather than recapitalize an insolvent central bank, euro-area members such as Germany would rather revert to using their own central banks to issue their own currencies, while employing the ECB as a political whipping boy and symbol of abject failure. After all, the ECB is headed by some Frenchy dude, not a sober-sided German banker. What the hell did they expect?

    As the ECB rightly perceives, its insolvency as a result of a Greek default would be a prelude to a euro crack-up and its own institutional demise. Last year when the crisis became apparent, the ECB initially resisted buying peripheral area debt. Now that it has done so on a large scale, its goose is cooked. In retrospect, we might call it ‘Operation Trojan Horse II.’

    Well done, Greek gladiators. Now let’s ‘do’ the Fed …

    1. monday1929

      The FED IS insolvent, no probably needed. I postulated months ago that the Fed will be used just as you say the ECB will be used. It is the “Bad Bank” and will provide politicians the chance to placate Progressive Populists and Hard Money gun nuts (not that there’s anything wrong with those)by shutting it down,
      “For The People”. They hope the same string pullers can repopulate its replacement. Perhaps, if Larry Summers keeps a low enough profile for a year or so he will be totally forgotten and can run the new enterprise.

      1. Jim Haygood

        The Fed’s pathetic capital ratio of just under 2 percent (far below what Basel III would permit for commercial banks) is exactly comparable to what Fannie and Freddie were running with, before they became wards of the state.

        Mortgages are notoriously hard to hedge, owing to their unstable duration. A combination of hedging losses and principal losses owing to bad underwriting took Fannie and Freddie down — but not before an army of 1,200 accountants descended on Fannie to attempt to untangle several years worth of overstated earnings.

        And what has the Fed loaded up its balance sheet with? Why, MBS — Mortgage Backed Securities. And where are the Fed’s auditors? By law, it’s exempt from audit. So, draw your own conclusions about the Fed’s solvency — I have. The most pertinent issue, should questions arise about the Fed’s solvency, is — what happens to the astronomically large $3.5 trillion, off balance sheet custody account? Although currency can’t be redeemed, the custody account certainly can be.

        Don’t be surprised if you see a line of limousines extending around the block at 33 Liberty Street some day soon. ‘Excuse me, may I borrow a bottle of Grey Poupon for my toast points?’ inquires a european-accented voice through an opened window, as agency yields billow higher with an awesome ferocity. We’re toasted, as it were.

  4. Another Gordon

    What’s all this about? The BBC is reporting that the UK is to nearly double its contribution to the IMF by adding £9bn to its subscription.

    Sounds like an emergeny fund raising to me. If Greek taxpayers can’t plug the holes then others will have to help save the bankers’ bacon. Or am I reading this wrong?

  5. A. Sofianitz

    It is a near certainty, that, given today’s events,

    1. Greece will not agree to the austerity measures on the table.
    2. Greece will default on its Euro sovereign indebtedness.

    Actually, this has been apparent for some time.

        1. Cedric Regula

          “Justify” is not the right term. In this case the issuers, governments, like cds because it probably lowers the yield they have to pay when they issue bonds. They didn’t care where the “insurance” comes from.

          It also increases the number of potential bond buyers, because many institutional investors may have limitations in their charters about what credit quality they can buy. But if they buy a cds along with the bond, it’s like transforming lead to gold and considered ok then.

          It’s just that there is no one that regulates the cds issuer like an insurance company, and no one really knows if there is adequate capital backing it.

          Also, US banking regs say if banks buy low rated debt and CDS on it, then this is treated as Tier 1 capital (the good kind) instead of Tier 2 capital (the buy and hope kind)

          But there is a lot out there where the cds guy is someone different then the bondholder. In the case of the PIG, big skew is US banks in CDS, French and German banks holding the bonds. I bet there are some spirited backroom talk at the IMF!

          1. Cedric Regula

            “But there is a lot out there where the cds guy is someone different then the bondholder.”

            Scratch is sentence. I started confusing myself.

            There is a CDS issuer, who is liable to pay out if there is a “credit event”.

            A bondholder may or may not buy CDS on his bond.

            A CDS holder might get paid for a “credit event” on a bond he doesn’t own.

        2. Yves Smith

          This is how BS works on Wall Street. If you are a consumer and something bad happens, tough luck. If you are a big financial player, they just rewrite the rules midstream.

          In 2005, the bankruptcy of Delphi was the first big test of the CDS market. The contracts said you had to present the bonds to get paid on the CDS. The CDS outstanding were a big multiple of the bonds (4X, now it would be much higher).

          The CDS people who were desperate to save their pet product realized there would be a scramble for the bonds and a lot of CDS protection buyers would be left with worthless contracts. So out of the blue they created a protocol for cash settling the CDS if you didn’t have the bonds.

          Think what would have happened if someone had tried suing to block that fix, or the fix had never been done. A lot of CDS protection buyers would have been burned, you would have seen CDS volumes fall, no one with an operating brain cell would buy CDS if he didn’t own or thought he’d have trouble getting his hand on bonds (which would keep CDS notional much lower than the value of the underlying bonds) and we would not have had a global financial crisis, just a really bad subprime meltdown (the CDS extended the housing bubble, created exposures considerably larger than that of the actual subprime bonds and concentrated those risks in highly leveraged financial institutions).

          1. Cedric Regula

            Yup. I remember when the subprime crisis first hit, Roubini mentioned there was 5x as many subprime CDS as subprime CDOs. However, he didn’t try to explain how that was supposed to all work out. I was reading banking shills at the time saying “That’s just a notational number. Notational means it all zeros out.” A lotta help they are.

            If I remember correctly the recent Kash Mansori posts on the PIG CDS exposure, I think the total CDS on PIG is only 30% of bond face value. So it’s much less of a problem that way this go around.

  6. Anjon R

    Check out this CNBC article titled: “Greece is not the next Lehman”

    That actually get’s me worried. It seems his main argument is that “people know better this time”. Hmmmm. Sounds an awful lot like Hankie P when he stated right before Lehman went down: “the markets have had time to prepare for this event, so everything will be fine! Pay no attention to the man behind the curtain!”

    Ok, he didn’t actually make the Wizard of Oz reference, but I figured I had a little creative license on that one

  7. FatCat!

    FatCat! here, so listen up MY stupid Greek peasants, because I am getting irate at your disobedience!

    You will pay ME what you owe me, or I will sell your peasant country piece by piece to the Turks, I will force your to learn Turkish in your schools, I will turn all your churches into mosques, and I will force you to worship Allah.

    If I see one more protest, one more complaint, I will turn your Mount Athos into a strip mine, and I will bulldoze your Acropolis and build a coal-burning plant in its place.

    If I see one more act of hooliganism against MY banks and MY corporations and MY politicians, I will order MY Blackwater paratroopers to invade your peasant country and kick ME some ignorant Greek ass.

    I want to see you return to your menial jobs with your heads down. I want you to take the paycuts I ordered. I want you to take my austerity with no modification. I want you to speak with respect of MY IMF and MY ECB and MY WorldBank and MY European Commission and MY Papandreou. I repeat: I want to see you keep your heads down. Is that clear?!

    I am FatCat! I rule the World. I own the world. I rule you! You do as I say or else!

    Is that clear?!


  8. skippy

    How do you restructure fraud…pray tell?

    Skippy…seriously…how do you take nothing, even thou its denominated in electrons, projected upon our retinas…in photons and make it…a solid…cough tangible asset, at least tulips were tangible.

    PS. does Samsonite have a refugee line of product[?] (bloody only thing CNBC can talk about {the worlds future depends on its IPO…LOL} full of win…if they do!!!!!

    1. psychohistorian

      The activities in Greece are just pulling back the corner of the carpet.

      So is the question of restructuring fraud or fear?

    2. FatCat!

      FatCat! speaking to you, Skippy, so listen up or else!

      Let me explain how rulers like ME restructure debt into real things:

      1. Install MY politicians into office, such as Papandou
      2. Loot Greek treasury via bailouts supported by MY politicians
      3. Lend the looted money to Greek nation for various stupid programs
      4. Crash the stupid Greek economy
      5. Send bill to stupid Greek nation
      6. Privatize Greek country
      7. Own Greek country with 10 million built-in cheap-labor desperate Greek serfs.
      8. Feel great about myself.

      Is that clear?!


      1. flavius minimus

        #3 needs a little elaboration. The money is FOR the programs. However, somehow it finds it’s way into the Swiss accounts of the leaders. It’s like a magic trick.

      2. Skippy

        @FatCat[!]…As an ex other people[s reduction elite squad (public and private) member / executive / managerial task master….nothing new here to me and may I say your doing a bang up job.

        Skippy…to think an entire species could be enslaved by electrons, take turns (fighting for the honor) feeding each other into your economic wood chipper…all I can say is *MASTER PIECE* & KUDOS!

        PS. When are you going to start the liquidation of the fat and Lazy executive classes…um…now that is when things will get interesting …eh.

  9. Mickey Marzick in Akron, Ohio

    That the TRILEMMA – the contradictions of representative government [state], national sovereignty [nation], and globalization/economic integration – is playing out in Greece, the birthplace of Western democracy, is fitting – if not ironic.

    A Greek tragedy in the making?

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