The Greek PSI

As you know, talks broke down last week between the Greek government and creditors over the terms of a private sector restructuring of Greece's debt.  Greece has approximately 250 billion euros of public debt outstanding, and about 206 billion of this is held in private hands.  October's EU summit set a goal of reaching a near 100% "voluntary" participation rate in haircutting this privately held debt by 50%.  If this could be achieved, we were told Greece would be on a sustainable path, with a debt/GDP ratio of a mere 120% by 2021**.  Furthermore, further IMF/EU bailouts have been made conditional on this level of debt reduction.  As Greece is dependent on an additional tranche of bailout money for a 14.4 billion euro bond redemption on March 20th, the PSI issue is becoming critical.

Greece's creditors include European banks, insurance companies, sovereign wealth funds,  hedge funds, and distressed debt specialists.  We can further divide these groups into:

-- those responsible for their own losses,
-- those who answer to the public for their losses, and
 --those who, while technically responsible for their own losses, will get a bail-out.

I think looking at this way helps predict willingness to accept loss.  Banks, and to some extent insurance companies, are in the third category.  As a result, they are probably more vulnerable to official sector pressure to cooperate, and less concerned with the consequences of a loss.  In fact, in the case of some of the banks, a realized loss on Greek debt might fit very nicely into their recapitalization scenarios as a tax provisioning scheme (think Citigroup).

Hedge funds are another story altogether.  By some estimates, these funds may have control of around 80 billion of the 206 billion total in private hands.  Obviously, these are holders who are solely responsible for their own gains/losses.  Furthermore, many of these funds are relatively new investors in Greek debt, having bought it from delevering European banks over the past year or less.  Given the obvious risks clearly visible in their investments, as well as their late entry into the market, many of these funds have paid quite handsomely for CDS (Credit Default Swap) protection on their positions.  (For the most part, they did not get Greek CDS when they were trading at reasonable rates, although undoubtedly the cleverer ones most certainly did, and the bond purchases were just another facet of their longer term strategy.)  These funds have disincentives to hold out for anything other than either par payment on their Greek bonds or a hard default that triggers payments on their CDS protection.

Sovereign wealth funds are an interesting category.  Obviously, they answer to the public for their losses, and bailouts really don't apply here.  They are interesting because they bring the biggest single hold-out in the Greek restructuring talks out of the shadows.  That hold-out is, of course, the ECB, which is estimated to be the largest single holder of Greek sovereign debt at approximately 45 billion euros.  The ECB has clearly held that it is not in the private sector, and will not be part of the current restructuring.  Obviously, sovereign wealth funds make a similar argument - their bonds should be pari passu with the ECB.

So, what pressure can Greece bring on its creditors to cooperate?  The answer comes in the form of retro-active collective action clauses (CAC), a measure which is currently under consideration in the Greek Parliament.  The presence of these clauses could force the hand of any restructuring hold-outs - as long as they remain a minority.  However, CAC's, and particularly retro-active CAC's, raise other issues.

1. CDS related:  While the enactment of a retro-active CAC would not be a triggering event, almost certainly its enforcement would be.
2. ECB related:  In a sovereign default, all bondholders are supposed to be pari passu.  This is a principle that dates back to the first Paris Club restructuring in 1956.  While the current effort to get private holders to voluntarily restructure could spare the ECB, a forced restructuring via a CAC would be legally much trickier unless all remaining bondholders were involved - to include the ECB.  In this sense, the ECB is in a tough spot.  If it partakes in restructuring it realizes losses against a highly leveraged 80 billion euro capital base and will likely have to make capital calls to its already strapped shareholders.  If it insists on immunity from restructuring, it makes it crystal clear to holders of EU sovereign debt that, in the event of a future restructuring, haircuts will be larger based on the ECB's non-participation.  Holders of Spanish and Italian debt will realize that they were effectively subordinated by the ECB's large SMP purchases in August, and may demand yields that reflect this increased exposure.  Of course, the December EU summit declaration made some cleverly worded promises about PSI being unique to the Greek situation, while paradoxically putting CAC's into all future EU sovereign bond issuances.  I was certainly not convinced, nor was Standard and Poors, as their downgrade statement makes clear:

            "As we noted previously, we expect eurozone policymakers will accord ESM de-facto preferred creditor status in the event of a eurozone sovereign default. We believe that the prospect of subordination to a large creditor, which would have a key role in any future debt rescheduling, would make a lasting contribution to the rise in long-term government bond yields of lower-rated eurozone sovereigns and may reduce their future market access."  (S&P)

            Obviously, this issue of ECB purchases subordinating other holders would be a huge issue in the event of a large scale QE program by the ECB.

**Since those estimates were published, the Greek situation has deteriorated considerably. "J.P. Morgan warned in October that based on a 75 billion euros write-off and its expectations of a long recession, debt could reach 190% of GDP."  (WSJ)

References:

Dealing with Greece’s biggest holdout (FTAV)

The Threats to Greece’s Debt Deal (WSJ)

No Finale for Greek Debt Drama (WSJ)

Awaiting a Greek Payout (NY Times)

Greece Will Wipe Away The Draghi Magic (WSJ)

UPDATE 5-Debt talks falter, Greeks warn of disaster (Reuters)

Hedge Funds Try to Profit From Greece Debt Swap (Bloomberg)

Euro Checkers: Guide to Greek PSI (WSJ)

Credit FAQ: Factors Behind Our Rating Actions On Eurozone Sovereign Governments (S&P)

Vega Threatens Lawsuit Over Greek Debt Talks (FINAlternatives)

Hedge Funds Complicate Greek Bailout (FINAlternatives)

Greece’s creditors seek end to deadlock (FT)

Greece: Disagreement Everywhere, Rift in the Troika (Testosterone Pit)

I still plan on doing a post about possible ECB QE, but am finding the time to do so in short supply.

Fascinating Factoid:

Apple Computer; 30,000 people; Yearly Revenue $100 Bil
Greece: 11 million people, Yearly Revenue $300 Bil