Tuesday, February 21, 2012

The truth about the latest Greek economic bailout

European financial authorities are trumpeting their triumph at having finally reached (another) bailout deal for Greece. Don't believe them. It's all a lie. The 'bailout' is nothing more than the financial equivalent of rearranging the deckchairs on the Titanic. Here's why.

1. Greece has not avoided defaulting on its debts (as claimed by proponents of the bailout package) except in a purely technical sense. Instead, it's imposing a default on its private (i.e. non-state) creditors, by insisting that they accept a 'haircut' of approximately 70% of what they're owed. In other words, if you own Greek bonds worth (say) $100 million, you will now be forced to give up 70% of their face value, accepting in exchange new bonds with a much later maturity date, a much lower interest rate, and no insurance coverage to guarantee that you'll ever see your money again. As for the remaining 30% . . . if you're lucky, you might get it back. Someday. Also, note that Greece is effectively imposing this condition upon its private bondholders. Oh, the newspapers will speak of an 'agreement' to do so; but when a sovereign government is telling investors that unless they agree, it'll pass legislation to implement the deal whether they like it or not . . . just how 'voluntary' is that 'agreement'? (There are indications that Greece may not have the legal authority to impose such a 'haircut' on certain classes of bonds. If it tries to do so anyway, in defiance of international law, this may provoke yet another crisis.)

2. The agreement imposing the 'haircut' means that, because Greece hasn't technically 'defaulted' on its debt obligations, the credit default swap (CDS) agreements that provide insurance against such defaults will not go into effect. To put this in simple terms: when you bought your $100 million of Greek bonds, you also bought a CDS - an insurance policy - saying, in effect, that if Greece didn't repay what was owed, the seller of the CDS would do so. However, the seller of the CDS can - and will! - now turn around and say, "Since you're a legal party to the terms of the Greek bailout, that means your losses are voluntary; therefore, I won't compensate you for them." The fact that you're an involuntary legal party to the agreement is basically irrelevant. The bailout agreement therefore nullifies contracts of insurance that private-sector investors relied upon to cover their investment in sovereign debt. After that experience, just how willing do you think such investors will be to purchase more of the sovereign debt of any weaker Eurozone nation in future? (There's also the real possibility that some holders of Greek bonds may insist that they be compensated for their losses, even to the extent of suing the sellers of their CDS's. This might bring down the entire CDS system - and what that would do to all future private investment in sovereign debt, I leave to your imagination!)

Economist and political commentator Rodney Shakespeare goes so far as to refer to the bailout deal as 'the banking occupation of Greece' and 'a fraud'.

The real, fundamental problems of the Eurozone - epitomized by the Greek fiasco - have merely been punted down the road for a few months. I can't believe we won't see a further crisis involving Greece within six to nine months from now. Furthermore, the underlying cause of the problem - the unsustainable Euro itself - hasn't been addressed at all.

Here's my prediction: this is going to blow up in the faces of all concerned before the end of the year. If I'm wrong, I'll gladly eat crow on this blog in public . . . but I don't expect to have to do so.



EDITED TO ADD: Less than half a day after I wrote this, Fitch came out with its own views - and they confirm mine. According to CNBC:

Fitch ratings agency on Wednesday slashed its rating for Greek sovereign debt to “C” from “CCC”, indicating that default is “highly likely in the near term”.

. . .

“In Fitch's opinion, the exchange, if completed, would constitute a 'distressed debt exchange' (DDE) in line with its criteria and consequently yesterday's announcements set in motion the agency's process for reviewing Greece's issuer and debt securities ratings,” Fitch said in a statement.

That rating downgrade puts Greece's sovereign debt below (i.e. worse than) junk bond status. Why am I not surprised?


John Peddie (Toronto) said...

If they can't pay their bills in money, we'll "take it out in trade".

Sun-drenched island vacations with all the souvlaki we can eat.

I'm in!

DaddyBear said...

I can't wait for their next bond auction. Who's bringing the popcorn?