Another Great Clarke and Dawes Skit in the making - Who's on First? (Naked Capitalism)

SATURDAY, JULY 9, 2011

Satyajit Das: Bailing In to Bail Out – The Greek Bank Debt Exchange Proposal

By Satyajit Das, the author of Extreme Money: The Masters of the Universe and the Cult of Risk (Forthcoming September 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

The proposal to extend the maturity of Greek bonds emanating from the Élysée Palace reflects French strengths first identified by Napoleon III: “We do not make reforms in France; we make revolution.” Structured to meet a German requirement that private creditors contribute to the Greek bailout, the proposal falls short of what is actually required.

Under the sketchy proposal, for every Euro 100 of maturing bonds, the banks will subscribe to new 30 year securities, but only equal to Euro 70 (70%). Of the Euro 70, the banks, in turn, will only give Greece Euro 50 (50%) and invest the other Euro 20 (20%) in 30 year high quality zero coupon bonds (via a special purpose vehicle) to secure repayment of the new bonds. The new 30 year Greek debt will carry an interest rate of 5.5% per annum with a bonus element linked to Greek growth of up to an additional 2.5% per annum.

Of the Euro 340 billion in outstanding Greek bonds, banks hold 27%, institutional and retail investors hold 43% and the International Monetary Fund (“IMF”) and the European Central Bank (“ECB”) hold 30%. It is not clear whether non-bank investors are willing to participate in the arrangements. The ECB has previously resisted any debt restructuring, including maturity extension.

The French plan assumes holders of bonds would agree to roll over 50% of their holdings to provide Greece net funding of Euro 30 billion. But under the French banking federation’s own figures, this would if impossible unless all the Euro 60.5 billion (excluding central bank holdings) maturing by mid-2014 is rolled over. This is inconsistent with the proposal’s assumption of investor acceptance of 80%.

As not all Greek debt trades at the same price in the secondary market, if all bonds maturing are not rolled over, then banks could arbitrage the offer exchanging bonds trading at a deep discount, holding on to those trading at better prices.

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