Very conveniently, only after the ECB completed their bond swap with Greece today for brand new shiny bonds, which effectively ends the IMF's campaign to get the ECB to take a loss either real or on profits to help bring Greek GDP to a sustainable level (something Draghi said he would not do and has remained true to his word) and only AFTER the European market closed, does this news come out from Bloomberg about the formerly theoretical option of retroactive, Collective Action Clauses meant to force any private sector holdouts to take losses of 50-70%.
Greece Said Prepares Collective Action Clause
"The law may be introduced to parliament in Athens in the coming days, said one of the officials, who spoke on condition of anonymity because the deliberations are confidential. Euro region finance ministers are prepared to back the use of so- called collective action clauses if a voluntary debt swap doesn’t draw enough participation, the other person said."
If the new bonds are worth half of par of the former bonds and the ECB has buying them at $.50 on th dollar which is about right, the ECB TAKES NO LOSS and rest assured whatever the details, it will be shown the ECB TOOK NO LOSSES on the swap. The same can't be said for private bond holders, especially if Greece does what it appears set to do, force the losses through retroactive CACS, which is changing the rules of the game in the middle of the game to assure you win.
The problem for Greece and why Greece will almost certainly default next week (and the repercussions of which I will address in a moment), is that the rating's agencies have already made clear what constitutes a default.
The terms are clear in this WSJ article today:
Could ECB Greek Bond Swap Trigger Ratings Default?
All three major ratings firms in recent months have said that a bond exchange where Greece replaces current outstanding bonds with new bonds that include worse terms for the bond holders would constitute a default.
Depending on the details of the debt swap the ECB just completed, that could be enough to trigger a ratings default in the eyes of the ratings companies.
Here’s what Fitch said last July about a possible Greek bond swap:
An exchange that offers new securities with terms that are worse than the original contractual terms of the existing debt and where the sovereign is subject to financial distress constitutes a default event under Fitch’s ‘Coercive Debt Exchange Criteria.’
In line with the rating approach outlined by the agency on 6 June 2011, Fitch will place the Greek sovereign rating into ‘Restricted Default’ and assign ‘Default’ ratings to the affected Greek government bonds on the date that the offer period for the proposed debt exchange closes.”
S&P and Moody’s have made similar comments in the past as well.
Here's how the ECB could make the swap without losing any gains and still trigger a default...
The ECB won’t book any profits or losses on its bond swap, but that might be enough to be considered default. If, for example, the ECB purchased the bonds at 50 cents on the dollar and the new bonds are now worth what the ECB paid that would mean the new bonds are worth less than the face value of the original bonds. While the ECB would come out without making or losing money, to ratings firms that would be considered a reduction in the value of the bonds and should theoretically trigger a default.
If the ECB debt swap doesn’t trigger a default by Fitch, S&P and Moody’s, the expected private sector bond exchange could easily clinch that distinction for Greece.
Regarding the CACs...
The private sector bond swap aims to cut the value of the bonds currently outstanding by half, which would be a clear loss for bond holders and meet ratings firms criteria for default.
A second avenue for a downgrade to default could come if Greece’s parliament passes legislation introducing a so-called collective-action clause and retroactively applying it to outstanding debt. The clauses say that if a certain portion of bond holders agree to a debt restructuring every single bond outstanding is subject to the same restructuring.
S&P said earlier this month that even retroactively adding that clause whether it is used or not could be enough to consider Greece in default because it is materially changing the terms of the debt.
And how this could effect the market...
In recent week Financial Credit both in the EU and US has been selling off, these are the smart players with the best information so it is likely they knew about what we are just hearing, weeks ago.
Banks have been writing CDS, which in simple terms is insurance against a default. As an insurance agent, I've seen many firms driven either out of Florida or out of business when a payout came due because of a hurricane. I am not trying to insult anyone's intelligence, just trying to break this down very simply. As a writer of an insurance policy, you are betting the probabilities of an event triggering payment are low, as a buyer of insurance, you are betting they are high in the simplest of terms.
All of these financial institutions across the globe, but especially in the EU and US companies via their EU affiliates, have been writing Credit Default Swaps, insurance against a default that now looks virtually certain, this will force massive payouts by the financial firms that wrote the CDS as a way to generate extra income. This certainly cold effect the next LTRO, but that may not come in time to prevent hundreds of companies from losing tons of money, liquidity, bank runs, and who can imagine what else. Perhaps this is why as I mentioned last night, Financials broadly are underperforming and even more so in credit, probably the only players that understand the consequences as equity traders simply watch price and aren't usually very forward looking when it comes to consequences of difficult subject matter. If their 50 bar/200 bar moving average doesn't tell them, they don't know.
So the timing was convenient and early next week, more then a month before the market expects a possible default, Greece may in fact be in default. If Lehman could do what it did to our markets and all of the unexpected consequences, imagine what a nation can do, especially when hundreds of banks are tangled in the mess.
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