The Greek Bail Out, the CDS Market, and the End of the World
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March 2, 2012
By Shah Gilani, Capital Waves Strategist, Money Morning
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."
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."
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