Long Long Ago
In the early mid 2000s, Greece’s economy was one of the fastest growing in the eurozone and the government took advantage of it by running a large structural deficit, partly due to 2004 Athen’s Summer Olympics and partly due to high defense spending amid historic enmity to Turkey. As the world economy cooled in the late 2000s, Greece was hit damn hard because of its main industries (shipping and tourism) twindling — which were very much sensitive to changes in the business cycle. As a result, the country’s debt began to pile up swiftly because of the high number of bonds the country had issued.
Moreover, these Greek bonds have been resold as Credit Default Swaps(CDS)
to the US and European market.(The Credit Default Swaps are insurance policies, individually written between 2 firms, that basically say – if Greece defaults to pay you, we’ll pay you what Greece should have paid you.)
As the world wide economy imploded in 2008 due to sub-prime crisis, the house of cards of sovereign debt in Europe began to collapse.Portugal, Ireland, Italy, Spain and Greece (collectively called as PIIGS
) were at the forefront of the crisis.
Greece was at the receiving end largely due to its deficit budgets and lavish spending.In 2010, there was a bailout of 45 billion euro($61 billion) from European Union(EU) & International Monetary Fund(IMF) to save Greece from default, since majority of Greece’s sovereign debts are held in EU.
Greece’s current debt amount lies at 350-billion-euros ($460 billion).The current scenario is Greece needs more money now,despite the 2010 bailout since a large portions of these bonds are maturing/closing by March 20, by which Greece needs to pay back the money to the bond holders. If not Greece would face a sovereign default.
Current credit ratings for Greece – Fitch rates it CCC, S&P rates it CC and Moody’s with Ca.
Bond Swap Deal
Greece has come forward with a important debt relief deal with the private investors to avoid a catastrophic default. The agreement will help shield Europe’s already weak financial system, even though banks, pension funds and other bond investors have to accept multi-billion-dollar losses.
Greek Government needs to clinch the agreement quickly to qualify for more bailout loans before it faces a massive debt repayment.Without the bond swap deal, Greece will be cut off from its rescue loans.
By this new deal, Banks, hedge funds, pension funds and other private investors who own around 200 billion euro in Greek government bonds have been asked to forgive Greece 53.5 percent of the face value of those bonds. That would be achieved by swapping their existing bonds with new ones with a longer maturity period and possibly lower interest rates.This could immediately cut Greece’s 350-billion-euro ($460 billion) debt by 107 billion euros ($142 billion) and will also give 30 years to repay those bonds.
Right now, Greek has been ordered to take austerity measures to control government spending and increase taxes to achieve budget surplus until 2020.
Why Should bond holders take a loss?
Certainty is that Greece will not be able to pay its debts fully by March 20, so if the bond holders dont enter this deal, they obviously get nothing when Greece defaults.(Something is better for nothing)
What if Greece defaults ?
That would threaten the Greek’s position in the 17-nation euro, spread the crisis rapidly to other eurozone countries by making it harder for them to borrow money on international markets. Eventually Euro will weaken as a currency .
Big Pocket – CDS
Some private investors and banks might opt out of this deal so as to trigger the Credit Default Swap , which might ask the insurers of Greek bonds to repay instead of Greece.Eventually these firms who have invested in CDSs would try to make large profits with Greece default.
But however the decision to trigger CDSs is made by the International Swaps and Derivatives Association(ISDA)
, based in New York, which is heavily influenced by US’s top 5 banks and infact they hold more than 95% of the CDSs. Eventually these 5 Big B’s would not allow triggering of CDS, by declaring any haircut(of losses) on bond value cannot be termed a default event.
In Addition, Greece will put in collective action clauses, or CACs, into their bond contracts that would eventually make the bond swap deal binding to all if the majority of bondholders agree to a debt relief and it prevents a small portion of creditors from derailing the agreement
If such thing happens, one shouldn’t be suprised to see the US Economy wipe out because of the CDS.
For those who are thinking that the 2008 economic crisis was over. Just take a hold back and be ready to realize what you have witnessed is just a glimpse of a much larger picture than you imagined.
And the Irony is Nobody has a clue how large the picture actually is!