The latest developments in Europe's financial crisis

Earlier this week I noted that 'The next two weeks are going to be interesting', as Greece was about to hit two major milestones that might derail its recovery. Well, it managed to squeeze past the first milestone: it's reported that holders of 85.8% of its bonds agreed to accept a 70% 'haircut' in order to prevent a complete default and a total loss. I've no idea how much arm-twisting was involved, but I'm sure screams of fiscal anguish resounded down many European financial corridors over the past few days!

Greece will now legally require the remaining holders of bonds issued under Greek law to accept the deal, using so-called 'collective action clauses' or CAC's to force them into line. This will bring participation up to 95.7%. (I might add that the CAC's weren't part of the bonds' original contract - they were imposed retroactively by the Greek parliament. As you can imagine, this has led to much weeping, wailing and gnashing of teeth among bondholders, who don't appreciate such legislative chicanery and dishonesty any more than you or I.) The remaining bonds are issued under laws other than Greece's, and thus cannot be forced into compliance - at least, not legally. If Greece tries to do so, expect legal storms to erupt across Europe.

I also mentioned last week that, as I'd predicted earlier, the ISDA was refusing to declare Greece in default on its bond obligations, thereby avoiding triggering the credit default swap insurance provisions that were protecting many bondholders. However, S&P had declared last month that Greece would be in default if it managed to enforce the proposed bond 'haircut'. Fitch and Moody's, the other two members of the 'Big Three' credit rating agencies, today joined it in declaring that Greece was now in default. In the face of such unanimity, the ISDA could no longer maintain its aloofness and pretend that things had not reached the point of default. Today it reversed its position. It'll now be liable for billions of dollars to cover bondholders' losses . . . and it'll seek to claim back those billions of dollars from its reinsurers.

The ISDA's attempts at evasion have not gone unnoticed, and have probably weakened its authority in financial markets. As the Financial Times pointed out:

... there will be a net pay-out of about $3bn on CDS contracts, according to the data warehouse Depository Trust & Clearing Corp, in a boost for the relatively new market in sovereign debt protection that could also benefit eurozone debt markets amid worries that a failure to trigger could have undermined an important hedging instrument for holding government bonds.

However, there was a long delay over the decision by the ISDA determinations committee, which is made up of 15 global banks and investment funds, that annoyed some investors.

Uncertainty still hangs over the CDS market as an auction process to decide the amount of pay-outs may not take place for another week.

Bill Gross, who runs the world’s biggest private bond fund at Pimco, warned that CDS had been undermined by the saga. “The rules have been changed here,” he said in a radio interview. “The sanctity of their contracts is certainly lessened.”

There's more at the link.

Ambrose Evans-Pritchard doesn't pull his punches when he notes that the Greek bailout is nothing more or less than 'legal skullduggery'.

Europe has ring-fenced Greece's debt crisis for now but its escalating recourse to legal legerdemain has shattered the trust of global bond markets and may ultimately expose Portugal, Spain, and Italy to greater danger.

"The rule of law has been treated with contempt," said Marc Ostwald from Monument Securities. "This will lead to litigation for the next ten years. It has become a massive impediment for long-term investors, and people will now be very wary about Portugal."

At the start of the crisis EU leaders declared it unthinkable that any eurozone state should require debt relief, let alone default. Each pledge was breached, and the haircut imposed on banks, insurers, and pension funds ratcheted up to 75pc.

Last month the European Central Bank exercised its droit du seigneur, exempting itself from loses on Greek bonds. The instant effect was to concentrate more loss on other bondholders. "This has set a major precedent," said Marchel Alexandrovich from Jefferies Fixed Income. "It does not matter how often the EU authorities repeat that Greece is a 'one-off' case, nobody in the markets believes them."

The ECB holds €220bn (£185bn) of Greek, Portuguese, Irish, Spanish, and Italian bonds. Its handling of Greece implicitly subordinates private creditors in each country. All have slipped a notch down the pecking order.

The Greek parliament's retroactive law last month to insert collective action clauses (CACs) into its bonds to coerce creditor hold-outs has added a fresh twist. These CAC's are likely to be activated over coming days. Use of retroactive laws to change contracts is anathema in credit markets.

This might not matter too much if Greece were really a "one-off" case but markets are afraid that Portugal will tip into the same downward spiral as austerity starts to bite.

. . .

The risk for Europe is that investors will charge a "political risk" premium to invest in any EMU country subject to EU legal whim. The greater risk is that Euroland's crisis rumbles on as fiscal contraction in Italy and Spain plays havoc with debt dynamics, and reforms come much to late to close the North-South trade gap.

Europe's handling of Greece has guaranteed that global funds will rush for Club Med exits at the first sign of trouble. The next spasm of the debt crisis will that much dangerous if it ever comes. As the saying goes: Hell hath no fury like an abused bondholder.

Again, more at the link.

The next crucial milestone occurs on March 20th, when Greece must pay out some 14.5 billion Euros to bondholders. It must receive the latest Eurozone bailout of about 130 billion Euros prior to that date, of which it will pay almost 100 billion Euros to bankers at once. It'll use the balance to pay the bondholders . . . or will it? There's already pressure from some elements in Greece to take the bailout, retain as much of it as possible to keep the economy afloat, pay out as little as possible to anyone else, and then default on the scheduled payment. If that happens, things are going to get very tricky indeed . . .

Peter