Last week the Greek government,
with the heavy handed support of its larger friends in the Eurozone,
succeeded in coercing some 85.8 percent of private sector bondholders to
"voluntarily" exchange €206 billion-worth of Greek
sovereign bonds for newer bonds with longer maturities, lower coupon
rates, and a face value of 53.5 percent less than the original paper. The
benignly termed "haircut" (more accurately described as a
"scalping") is particularly painful for those buyers who were
literally strong armed by their own governments into buying Greek bonds
in the hopes of achieving regional financial stability.
A monstrous creation of political
expediency, the deal may have solved Greece's short-term funding of some
$19 billion in bonds due on March 20th, and secured the likelihood of its
receipt of an additional $170 billion package bailout. While it is still
far too early to tell if the agreement does anything beyond kicking the can
down the road a few paces, the immediate lessons are easier to grasp.
Most strikingly, this episode reveals just how cheaply the rights of
private bondholders will be held in the new world of sovereign bailouts.
One particularly pernicious
aspect of the settlement was the declaration that the European Central
Bank (ECB) deemed itself to be 'senior' to all other bondholders and was
thusly able to recoup all its invested
principal. This unilateral action should justifiably shock traditional
private bond buyers worldwide. Previously, such draconian and politically
self-seeking actions would have been the purview of revolutionary
tyrannies, not the modus operandi of staid Continental bankers.
Equally troubling was the
underhanded manner in which the Greek government used collective action
clauses to pressure bondholders to accept a 'voluntary' swap. Using these
legal devices, even those who had said "no" were declared
retroactively to have said "yes." In this manner, more than 90%
of bondholders are now on board. The Soviets could not run a better
At the last hour, the whole messy
deal was deemed a 'credit event' by the International Swaps and
Derivatives Association thereby triggering payments of so-called credit
default swaps (CDS). Interestingly, investors only learned of these
modest reimbursements after the deal was finalized. This delayed decision
could fuel suspicions that the action was deliberately timed to bring
pressure on bondholders to accept the Greek government swap offer.
These three official actions
likely will erode confidence quietly and will create extensive long-term
damage to the image of government bonds as a riskless asset class. Coming
at a time of recession and increased government spending, it could herald
acute funding difficulties for less creditworthy nations. It may also
scare some private buyers away from the highest rated sovereign debt,
leaving central bankers as the increasingly dominant market maker. An analysis of this problem
can be found in the latest issue of Euro Pacific's newsletter.
Forgetting the lessons of the
pre-Bretton Woods era, many institutional investors had been lulled into
the fond belief that in the modern world governments of politically
important developed nations would not default. This belief had allowed
many nations to borrow massively even as they failed to address fiscal
imbalances. The Greek default should shatter this belief.
At its core, this deal was a
means to protect the financial status quo. And from my perspective the
biggest losers, worse off even than the private bondholders, are Greek
citizens who must live under the weight of a crushing austerity imposed
upon them from without. It would have been far better for the rank and
file Greeks if their government had been allowed to default the old
fashioned way, and all lenders, public and private would have been made
to pay, in full, for their ill-advised loans. In so doing, a newly
impoverished Greece would have at least a real chance for a fresh start.
The unemployment rate among young
Greeks is some 51 percent. Unless the situation reverses itself quickly
and decisively, Greece may never be able to repay even a much reduced
debt burden. In the meantime, the Greek people will be subject to
inescapable poverty. But it need not happen. Some four years ago, Iceland
put ECB austerity proposals to a referendum. The people voted for
default. Now it appears as if Iceland is on the road to recovery. Last
month, S&P raised Iceland's credit rating, illustrating what may
happen if free markets are allowed to function. Greece may be an example
of the dangers of best laid plans.