Greek Restructuring: The Dominant Media Frenzy for the Past 6 Months

Image Source: The Economist

For weeks, the market was perfectly in tune with the news released about the Greek government and the Eurozone. If there was good news indicating a fix the Eurozone problems, the market was up and vice-versa. That game finally ran its course when news surfaced that the Greek government would need a second round of bailout funds by March 20^th to avert a default on €14.5 billion worth of bonds coming due. Investors feared that a failure to obtain these funds could trigger another round of global financial meltdowns.

It’s important to recognize that the Eurozone debt problems date back to late 2008, when the Eurozone agreed on its first stimulus package of €200 billion. In April of 2009, the EU ordered France, Spain, Ireland and Greece to reduce their budget deficits and then in November, the EU, following the Dubai sovereign debt crisis, began investigating the balance sheets of all of its members. Their exploration found that Greece’s debt burdened amounted to 113% of GDP, nearly double the allowable Eurozone limit of 60%. The following year (2010) can be characterized as a year of bailouts. The Eurozone and the IMF gave Greece €22 billion initially, but followed that up with another bailout package of €110 billion later in the year after revised Greek deficit figures were worse than originally reported. The EU and IMF then agreed to bail out Ireland with €85 billion. The bailouts were not finished. In 2011, €78 billion was given to Portugal and ANOTHER €109 billion was given to Greece with the hopes of resolving their crisis and preventing contagion among other European economies. It would take pages to fully delve into the EU’s decisions over the past three years, but at this point, the burden that Greece has put on the European and global economy should be evident.

In return for another €130 billion in bailout funds, Greek MP’s passed a controversial package of austerity measures on February 12, 2012. Riots ensued, but the government ensured that this package would set the foundation for future economic solidarity. The austerity measures included job and salary cuts for government workers, pension reforms, public sector job cuts, and a lowering of the minimum wage. Another part of the debt exchange meant private bondholders were expected to take a hefty loss (a 53.5% write-down) as Greece swaps out its existing debt for new, longer term bonds with lower interest rates. The terms of the bill aim to not only decrease government spending in general, but to decrease Greece’s debt from its current level of 160% of GDP to 120% by 2020.

At the forefront of Greece’s effort to force private bondholders to accept sizeable haircuts is the actions’ relation to outstanding credit default swaps on Greek debt which were designed to transfer the credit exposure of fixed income products between parties. The purchaser of a swap receives credit protection while the seller guarantees the credit worthiness of the debt security. In doing so, the default risk associated with that debt security is transferred from the holder of the security to the seller of the swap. A CDS is basically considered insurance against non-payment, whereby “credit events” involving the underlying security incur compensation from the CDS issuer to the buyer. The question of whether this restructuring plan would be considered a Credit Event in the CDS market was the main focus amongst Greek CDS holders.

On March 9, 2012, the ISDA (International Swaps and Derivatives Association) announced that the recent restructuring deal is in fact considered a Credit Event. The determining factor of this decision was because the ISDA invoked the Collective Action Clause (CAC) which forced all holders of Greek debt to accept the exchange and write-down offer by the Greek government. The plan involves a “haircut” and is binding to all holders and thus, is considered a Restructuring Credit Event. The current CDS credit protection on Greek sovereign debt as of March 2^nd was approximately $3.2 billion. Although this is the largest sovereign CDS payment on record, many believe this is an amount that the markets can easily handle.

All in all, considering the healthy signal the CDS market provides coupled with the fact that CDS volume is at normal levels, one can conclude that the negative effects of the Greek restructuring on the CDS market and hopefully the global market as a whole have so far been averted. However, Greek solvency still remains questionable and judging by the Greek response to austerity, there has been no sign of real economic improvement. The true question is whether the markets have priced in all the negative possibilities with Greece and contagion in the Euro correctly this time. Should debt 'fears' arise again this summer, it will decrease confidence in the effectiveness of monetary policy and liquidity pumping policies of central banks. Even now, credit markets are not buying the fragile facade of recovery as equity markets rallied. This summer, we may see that divergence correct, one way or the other.

by Ryan Porter