~ ~ ~ ~

Friday 2 March 2012

The rather pronounced American guru Shah Gilani definitely doesn't mince words in discussing the financial Greek tragedy. In addition to his fluent penmanship, he has a thorough knowledge of what goes on behind the scenes in the very exclusive circles of the high financial and political world.

Global stock markets are down sharply for fear of a Greek bankruptcy. If less than 75% of the Greek creditors agree to a "voluntary" exchange of their old junk bonds for new Greek (junk...) bonds, the old ones will have to be written down to zero. The negotiations are made between the IIF (Institute of International Finance), which represents some 450 international financial institutions, and the Greek Government.

According to an internal confidential report of the IFF, an uncontrolled Greek default would cost the banks (and the governments) more than 1 billion Euro (or some 1.31 trillion dollars), and it would inevitably lead to Greece's withdrawal from the Eurozone. However, the international financial and political authorities have given birth to a remarkable solution, which consists of several layers!

The conditions of the proposed bond swap, which Greece has to accept before they receive more money, come down to a theoretical default, but not to a technical default...

Credit Default Swaps

Greece is (not yet) bankrupt, but some of the holders of the so-called credit default swaps (CDS), which actually is an insurance in case of bankruptcy, declare that the conditions of this exchange actually constitute a credit event or a default. So they want their insurance to pay them the balance. Superficially, this would seem to be a mere technical discussion about the proper definition of a default, but in fact the entire future of credit default swaps, and of the financial credit markets are at stake !

de Griekse ruïne Griekse schulden

The future of the Greek drama is obvious. As soon as on 20 March 2012, Greece has to reimburse fourteen billion euro. However, it doesn't have the money, not even after the previous 100 billion euro bailout. If it can not reimburse, Greece defaults and the bubble bursts.

Banks and governments must then revalue their Greek bonds, and probably completely write them down to zero. This in turn would cause a chain reaction in other European countries, which will then also be seen as vulnerable. What is likely to result in investors withdrawing their money in panic from insolvent banks, which in turn would have more international repercussions.

The Greek Bailout

For the next Greek "debt bailout" of 130 billion euro, the Troika of the European Central Bank (ECB), the European Union (EU), and the IMF propose that the "private" creditors (banks and investors) exchange their old bonds with a very high interest by new bonds, worth less than half, and yielding less than 4% interest. The principle is that it makes no sense to throw new money at Greece, if it doesn't dispose of the money to pay off even these new loans.

This exchange is called voluntarily, supposedly because the creditors act "spontaneously", given that they still will get something, against nothing if Greece defaults. The only reason for this rather peculiar proposal to bondholders, is that if the act is not "voluntarily", it would constitute a credit event. What exactly a "credit event" is, will be determined by a committee of 15 people, the Determination Committee of the ISDA (International Swaps and Derivatives Association), a private group of banks and traders in derivatives.

If this committee decides that this constitutes a "credit event", then the swap is a default, and the holders of "credit default swaps" have to be paid. However, this could then cause a "Lehmann-effect", and in turn produce a global shock wave. Nobody actually knows how many CDS were issued, and whether there is enough money available to pay for them. Who bought these CDS? The banks that hold Greek government paper. Who sold these CDS? Exactly the same Hedge funds and banks...

And we are not talking about peanuts ! Which banks hold Greek debt ? Let us have a look at the list, expressed in billions of dollars.

Japanese banks 0.43 Spanish banks 0.54
American banks 1.50 Italian banks 2.35
English banks 3.40 French banks 14.96
German banks 22.65 Greek banks 62.80
The ECB bought 40.00 billion euro in Greek Treasuries,
and loaned another 91.00 billion euro to Greek banks...

Furthermore, the very lucrative, but highly speculative derivatives market hangs over our heads like the sword of Damocles. An estimated 600 trillion (or 600,000 billion...) dollars in securities are hanging in limbo, the real value of which cannot even be evaluated anymore, but they do figure in the respective balances at full nominal value. As to the American derivatives, 95.9% of them are held by only four major banks : JPMorgan Chase, Citigroup, Bank of America, and Goldman Sachs...

The problem is even more complicated. Banks holding Greek government paper still mention these in their balance sheets at the nominal value, since they are insured. What happens to their balance sheets if they are not reimbursed by the insurance, or even worse, if they have to indemnify other bondholders? What if the insurer also defaults?

In this case it was therefore less important in what way Greece would obtain its next payment, but rather that the entire operation would not constitute a "credit event", which would launch the CDS contracts. But the situation became even more convoluted.

de ECB

The ECB did not want to take a loss on its 40 billion euro of Greek paper, which it had bought to support the market (and the politicians). So, it conveniently swapped it with the Greek government for "new" bonds, with a lower interest, but exempt from any nominal loss, as compared to those of the private bondholders.

Given the fact that the latter obviously became rather upset, and since not all of them might "voluntary" accept large losses, new covenants were retroactively inserted in the old bonds.

These so-called "collective action clauses" conveniently state that a 2/3 majority of the bondholders decide the vote, and that it binds all the bondholders !

Such dictatorial measures naturally cause resentment with the bondholders, but not with at all of them. As a compensation, the ECB euro printing presses ran full swing, and it grandly allowed two large "liquidity loans" to banks, with 489 billion euro on 21 December 2011, and another 530 billion euro on 29 February 2012. Incidentally, the euro now has the highest combined value of banknotes and coins in circulation in the entire world, having even surpassed the US dollar, with more than €890 billion in circulation ! These loans were allowed for three years, and they cost a paltry 1% interest... Which certainly must be a boost for the common European citizen, who continues to pay his 30-year mortgage at 5 or 6%...

The banks that wrote out CDS insurance obviously don't want to pay them, and the ECB took arbitrarily "arranged" its privileged position. But the retroactive insertion of covenants in contracts that did not contain them when they were written, does leave a very bitter aftertaste.

The Determination Committee (consisting of the same large European banks that hold Greek bonds and wrote out CDS to each other) quickly decided that the proposed swap was not a "credit event". However, they prudently added that this might change after all...

But the new problem is the "updated" definition of "credit default swaps". Are they worthless? Who will trust them in the future as being effective financial instruments? What happens with this (very lucrative) market of some 300 trillion dollars? Which bonds will still be accepted if they are not covered by insurance? Finally, what is the value of a bond, if it can be modified retroactively?

This Greek tragedy is apparently only the tip of the iceberg ...

~ ~ ~ ~

Friday 9 March 2012

A "Credit Event" after all...

More than 85% of the "private" creditors agreed "voluntarily" with the Greek bailout, and they write down some 75% of their original investment. However, after intense pressure the ISDA Determination Committee concluded that the Greek debt rescheduling effectively constituted a credit event. The decisive argument was that the agreement with the creditors was perhaps not entirely voluntary, since Greece voted laws to constrain the other parties.

Which (silently) amounts to saying that the entire "credit default swap" (CDS) is a de facto Greek default ! Which in turn launches the insurance on these swaps. The creditors are (temporarily) appeased, the next installment of Greek aid can be paid out, Greece is (just as temporarily) saved, and it gets rid of 107 billion euro in debt.

A much more decisive (but far less public) argument for the sudden reversal of the ISDA seems to be that the payoffs of the CDS insurers were not so heavy as was feared at first. The Italian bank Unicredit gets the largest bill, with some 240 million euros, and Deutsche Bank and BNP Paribas only have to pay some tens of millions of euro. In contrast, the British banks HSBC and RBS receive the largest payouts. But the entire amount of the insurance doesn't have to be paid out, as the creditors recover a part of their investment through the swap.

"The" Solution !

The sky is blue again, the financial sector is saved, Greece can continue for a little while, and the politicians can proudly trumpet achievement in this "historic" bailout. But then who is actually paying for the two bailout loans of 110 and 130 billion euro?

The banks received government guarantees for 30 billion euro on the new Greek bonds, in exchange for their "voluntary" waiver. Furthermore, they get a guarantee from all the governments that they won't have to "cooperate" in any new Greek rescue. All parties are profoundly aware that it is inevitable, but the next time it will entirely be passed on to the European taxpayer, through all kinds of camouflaged mechanisms that still have to be doctored out.

stapels euro's

The investment banks can write down their investments in their balance sheets with a depreciation of at least 75%, which in turn yields an interesting tax deduction, although much of the net loss will be compensated by the swap insurance. What ultimately comes down to a severe decline in tax returns. Finally, one must not forget the benevolent European "liquidity loans" to banks...

There remains actually only one other big debtor : the European taxpayer. He doesn't get anything out of the entire Greek adventure. The interest rate is forcefully manipulated by the government to melt away the mountain of private savings as snow under the sun, the huge budget deficits are partly offset by sophisticated or not-so-subtle new taxes, and partly by a steep, but equally strongly manipulated inflation.

So, what else is new ?...