Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Junior Gold Miners: New Yearly Lows! Will We See a Further Drop? - 23rd Jul 21
Best Forex Strategy for Consistent Profits - 23rd Jul 21
Popular Forex Brokers That You Might Want to Check Out - 22nd Jul 21
Bitcoin Black Swan - Will Crypto Currencies Get Banned? - 22nd Jul 21
Bitcoin Price Enters Stage #4 Excess Phase Peak Breakdown – Where To Next? - 22nd Jul 21
Powell Gave Congress Dovish Signs. Will It Help Gold Price? - 22nd Jul 21
What’s Next For Gold Is Always About The US Dollar - 22nd Jul 21
URGENT! ALL Windows 10 Users Must Do this NOW! Windows Image Backup Before it is Too Late! - 22nd Jul 21
Bitcoin Price CRASH, How to SELL BTC at $40k! Real Analysis vs Shill Coin Pumper's and Clueless Newbs - 21st Jul 21
Emotional Stock Traders React To Recent Market Rotation – Are You Ready For What’s Next? - 21st Jul 21
Killing Driveway Weeds FAST with a Pressure Washer - 8 months Later - Did it work?- Block Paving Weeds - 21st Jul 21
Post-Covid Stimulus Payouts & The US Fed Push Global Investors Deeper Into US Value Bubble - 21st Jul 21
What is Social Trading - 21st Jul 21
Would Transparency Help Crypto? - 21st Jul 21
AI Predicts US Tech Stocks Price Valuations Three Years Ahead (ASVF) - 20th Jul 21
Gold Asks: Has Inflation Already Peaked? - 20th Jul 21
FREE PASS to Analysis and Trend forecasts of 50+ Global Markets by Elliott Wave International - 20th Jul 21
Nissan to Create 1000s of jobs with electric vehicle investment in UK - 20th Jul 21
Bitcoin Halvings Price Forecast and Stock to Flow Analysis - 18th Jul 21
Dell S3220DGF Unboxing and Stand Assembly - 32 Inch 165hz Curved Gaming Monitor Amazon Discount - 18th Jul 21
What Does The Fed Mean By “Transitory Inflation” And Why Is It Important To Understand? - 18th Jul 21
Will the US stock market’s worsening breadth matter? - 18th Jul 21
Bitcoin Halving's Price Projection Forecasts Trend Trajectory - 18th Jul 21
Dell S3220DGF Price CRASH to £305! 32 Inch 165hz Curved Gaming Monitor Amazon Bargain - 16th Jul 21
Google, Amazon and Netflix are Scrambling For This Rare Gas - 16th Jul 21
Sheffield Millhouses Park New Children's Play Area July 2021 Vs Old Play Area - Better or Worse? - 16th Jul 21
Inflation Soars, Powell Remains Unmoved. What about Gold? - 16th Jul 21
Goldrunner: Gold Could Jump To $1,900-$2,100 In Next 30 days – Here’s Why - 15th Jul 21
Tips For Finding The Right Influencers - 15th Jul 21
ECB Changed Monetary Strategy. Will It Alter Gold’s Course? - 15th Jul 21
NASA And Big Tech Are Facing Off Over This Rare Gas - 15th Jul 21
Will the U.S. Dollar Lose Momentum In the Second Half of 2021? - 15th Jul 21
Bitcoin Stock to Flow Model Forecasts Infinity and Beyond! - 14th Jul 21
Proteomics: The Next Truly Massive Investing Opportunity - 14th Jul 21
Massive Solar Storm to Hit Earth 2025, Coronal Mass Ejection (CME) Danger and Protection Solutions - 14th Jul 21
Is This The Best Way To Play The Coming Helium Boom? - 14th Jul 21
Meet SuperMania and its Ever-Present Sidekick, SuperMeltdown - 14th Jul 21
How NFTs Are Shaking Up Arts Trading - 14th Jul 21
Gold: High Time to Move Out of the Penthouse - 13th Jul 21
Climb Aboard! Silver Should Run Up To $38 In Next 30 Days - 13th Jul 21
How Will Remote Work Impact the U.K. economy? - 13th Jul 21
Why Helium Stocks Are Set To Soar in 2021 - 13th Jul 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Greek Bailout, the CDS Market, and the End of the World

Interest-Rates / Eurozone Debt Crisis Mar 02, 2012 - 08:28 AM GMT

By: Money_Morning

Interest-Rates

Best Financial Markets Analysis ArticleShah Gilani writes: A not-so-funny thing happened on the way to the latest Greek bailout.

The terms and conditions of the bond swap Greece agreed to before getting another handout constitutes a theoretical default - but not a technical default.


That's not funny to CDS holders.

Greece hasn't defaulted (so far), but some of the buyers of credit default swaps, basically insurance policies that pay off if there is a default, claim the terms and conditions of the bond swap constitutes a "credit event" or default.

If it is, they want to get paid.

While on the surface this looks like a fight over the definition of a default, underneath the technicalities, the future of credit default swaps and credit markets is at stake.

In other words, the ongoing Greek tragedy is really becoming a global tragedy of epic proportions.

The Next Act in the Greek Bailout?

Here's the long and short of it.

Greece needs to make a 14 billion euro ($19 billion) payment on its huge outstanding debt on March 20, 2012.

The problem is Greece doesn't have the money, even after the previous 100 billion plus euro bailout.

If it doesn't make the payment it will be in default and all hell will break loose.

That means banks that hold Greek bonds won't get all their money back and they will have to write down Greek debts to zero.

That will trigger contagion as other countries in Europe will be seen as vulnerable to default too, and as panic in Europe grows from depositors trying to get their money out of insolvent banks, the spillover will infect world markets.

That's the case for contagion.

While cobbling together another bailout for Greece, this one worth 130 billion euros ($172 billion), the ECB, the EU, and the IMF (the Troika) are asking existing "private" bondholders, meaning banks and investors, to swap bonds they currently hold, with their high interest coupons, for bonds with half the face amount paying less than 4% interest.

The idea here is that there's no point in bailing out Greece with fresh money if it won't have enough money to make payments on the new debts it is incurring.

By swapping their existing bonds with a face value of 100 euros for new bonds with a face value of 50 euros (that's known as a 50% "haircut") and accepting a lot less interest, bondholders will be getting something as opposed to nothing if Greece defaulted and repudiated its outstanding debts.

The bond swap is being called "voluntary," meaning private investors will be swapping their bonds because they choose to.

There's only one reason to make such an unprecedented offer to existing bondholders, that's because if it wasn't voluntary it would constitute a "credit event."

Unanswered Questions Lurk Behind a Default

What constitutes a credit event is ultimately determined by a 15-member committee, known as the Determination Committee, within the International Swaps and Derivatives Association (a private group of derivatives dealers and bankers).

If the Committee says a credit event is a credit event, it constitutes a default and triggers the payment process, known as an auction, by which credit default swap holders get paid.

That's a global problem that nobody wanted to face and would likely trigger its own version of contagion.

No one knows exactly how much CDS paper has been issued and in the event of a default, who will owe whom how much, or if the counterparties that owe buyers of CDS insurance have the money to pay them.

So who bought a lot of this insurance? The banks that hold Greece's bonds bought CDS insurance.

Who did they buy the insurance from? Each other and hedge funds.

The problem is twofold when it comes to this scenario.

First, banks have been pretending that the Greek bonds they own and haven't marked down don't have to be marked down, because they have insurance on them.

Second, what will bank balance sheets look like if they have to pay out on the CDS paper they wrote, and what will they look like if they don't get paid by other banks or hedge funds that don't have the money?

What's more, what if there are insurance companies, like AIG (NYSE: AIG) that wrote them insurance and can't make good on it?

The unknowns are off the charts.

A Bad Situation Made Worse

In this case, it didn't matter how Greece was going to get its bailout money. What mattered was that it wasn't considered a "credit event," which would trigger the CDS contracts.

But, things got worse.

The ECB didn't want to take any hit or haircut on the 40 billion euros of Greek bonds it had bought to support the market. It swapped them with Greece for some new bonds that pay them less interest, but they didn't have to haircut the principal they're owed.

That was clever. You see, the new bonds they swapped for are, well, new bonds.

They aren't subject to the haircut that the private bondholders are being asked to take on the "old" bonds.

Nice trick, right? Yes, it was.

On top of that, as private bondholders got upset, it was decided that because not all of them might volunteer to take big losses, new, retroactive covenants would be put onto the old bonds.

These collective action clauses, or CACs, now allow a vote of 2/3 of existing bondholders to make decisions that all bondholders have to comply with.

All this is making CDS holders very angry. Well, not all of them.

The banks that wrote CDS insurance don't want to have to pay each other or anyone else. They'd rather hide behind the voluntary swap and get on with pretending Greece will survive.

But, by the ECB essentially screwing private bondholders by unilaterally taking a "senior" creditor position and by forcing collective action clauses on bondholders that never imagined buying bonds that had such clauses (they didn't when they bought them), the whole swap deal has created a hole in what constitutes a credit event.

Yesterday, the Determination Committee (made up mostly of the same big European banks that own Greek debt and wrote CDS paper to each other) determined the swap wouldn't constitute a credit event. Although they also said, that could change.

Even More Unanswered Questions

Now you know exactly how a de facto default doesn't become a "credit event."

The problem now is what to do about credit default swaps. Are they worthless?...

Will anyone ever trust them again as being legitimate insurance on credit instruments? What will happen to this $300 trillion market? ...

What will this mean for less than stellar debt issuers who are able to sell their suspect bonds because investors could buy default insurance?...

What does all this mean for the sanctity of contracts? After all, bonds are contracts.

Global markets are going to have to figure out the answers to these questions and what it will mean for future markets.

Today, it is completely muddled.

The best we can hope for is that there's time to figure it all out before skeptical investors pack it in and sell what they have no control over and have no faith in anymore.

Unfortunately, the Greek tragedy is only the first act.

[Editor's Note: Shah Gilani's free newsletter Wall Street Insights & Indictments has been an overnight success.

If you're not already signed up for Insights & Indictments, subscribe by clicking here.]

Source http://moneymorning.com/2012/03/02/the-greek-bail-out-the-cds-market-and-the-end-of-the-world/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in