First, private bondholders will get a 70%+ haircut, by trading their old Greek bonds for new ones. These new bonds will pay about 3% over a very long term. Once these new bonds hit the open market, what will they sell for? 50% of par? 35%? In other words, the new bonds are likely to be total junk, unless the market believes that getting 3% is a good deal because the EU is backing Greece. However, recent events show the questionable extent of this commitment. Thus way below par may be a good guess, unless future magic tricks by the EU come into play.
This raises another personal question: How can I short the new Greek bonds that will go to private bondholders? There is money to be made here.
Another key issue arises because European governmental entities are apparently able to rid themselves of their bonds at par. Doesn’t this new risk create an interest rate premium on ALL private purchases of sovereign debt in the future? In other words, if the risk to private investors in sovereign debt is far greater than that of government purchasers, shouldn’t the interest rates reflect that?
Specifically, will there be an immediate risk premium in bonds issued by Portugal, Spain, Italy and others?
As Bill Gross tweeted last week, “ECB subordinates all Greek debt holders & in so doing subordinates all holders of Euroland sovereign debt.” This subordination should show its face in a new interest rate premium.
Another important question is, how will the ratings agencies react to the deal? Will they call it a “default?” In last week’s Barber’s Chair, I addressed this issue in depth, concluding that they would. As I stated, “A duck by any other name is still a duck…It is not a daisy or a bluebird or a polar bear with feathers.” In my opinion, the ratings agencies should declare the Greek action a default, and they will.
But if there is a default, this raises another crucial question, How will this effect the credit default swap (CDS) market? A clear “default” would mean that CDS’s have played their proper role in guarding against defaults. But what if European government entities or others claim that the deal is not a “default.” Will CDS issuers try to not pay off? This could result in a decade of litigation, and muddy the entire CDS market. If a CDS will not pay off in the case of a clear default, what good is it? If CDS’s do pay off, how big will the damage be to the CDS issuers? Are we looking at another AIG contagion situation?
In sum, there are many unanswered questions that arise from the Greek debt deal. These questions and others are likely to result in an unclear picture for Europe and the world over the coming weeks and months. Be careful out there!!
Floyd at KOTM please follow me on Twitter @USKOTM
