Hot Greece

Yesterday–

The fundamental reality is that their economies can no longer support the inflated, leveraged, fictional values the holders of these worthless scraps of paper demand and the reckoning is going to come from their pockets simply because they’re the ones holding the hot potato.

Today-

Hedge Funds Scramble to Unload Greek Debt

By LANDON THOMAS JR., The New York Times

January 25, 2012, 7:29 am

Hedge funds that in the last month or so have purchased an estimated 4 billion euros ($5.2 billion) of beaten down Greek bonds that mature on March 20 are now trying to unload their positions, according to brokers and traders.

That is because it is becoming clear to one and all that Greece – under pressure from its financial backers – is preparing to impose a broad-based haircut that would hit all investors with a loss of 50 percent or more, whether they agree to the deal or not.

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Starting in December, the counterintuitive, go-long Greece bet was one of the more popular pitches made to funds in New York and London.

Investment banks – Merrill Lynch was particularly aggressive in recommending the trade, investors say – argued that even though Greece was near bankrupt, those who bought the paper maturing in March could double their money when Greece received its latest bailout tranche due that month.

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Now, with momentum building in Europe for an agreement on a 50 percent-plus haircut to be reached before March 20 – one that would be legally binding on all holders – the smart money is not looking so smart anymore.

Oh, but it gets so much better.

European Central Bank Moves to Avoid Loss on Greek Bonds

By LANDON THOMAS Jr. and JAMES KANTER, The New York Times

Published: January 24, 2012

For months, the proposed debt restructuring deal between Greece and its private sector creditors had excluded the central bank from taking a loss on its Greek bond holdings while banks and hedge funds would have losses of 50 percent or more.

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Private sector investors, including large European banks and hedge funds, have complained bitterly – and in some cases threatened legal action – over the central bank’s insistence that its 55 billion euros in Greek bonds were exempt from the loss that the private sector is facing, which some have estimated at 60 cents on the euro.

The central bank bought the bulk of its Greek bonds in 2010 in a failed attempt to stabilize Greece’s collapsing bond market, paying discounted prices of about 70 to 75 cents on the euro. As part of the current talks, the central bank might exchange its current bonds for a different form of Greek debt at a cost similar to that of the distressed bonds.

EU ratchets up pressure with Greek default threat

By Ambrose Evans-Pritchard, International Business Editor, The Telegraph

9:39PM GMT 24 Jan 2012

The head of the European Commission’s economics team Mario Buti said Brussels is prepared to allow credit default swaps (CDS) on Greek bonds to come into play if talks fail to reach a deal that gives Greece enough debt relief to claw its way back to viability. “Triggering CDS may have to be considered,” he said.

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Charlesa Dallara, the head of the International Institute for Finance (IIF) representing creditor banks, said EU officials were playing with fire by talking about default and demanded that the EU stick to the agreement reached last October.

“We put an offer on the table and it remains on the table. All parties need to contribute to the solution. We are wiping off the face of the earth €100bn in existing claims against Greece,” he told Bloomberg.

First Act of Greek Default Proceedings Drawing to a Close

Author: Claus Vistesen, EconoMonitor

January 24th, 2012

Let me be clear, absolutely clear, here. Within any conceivably realistic macroeconomic model, there is no way that Greece can reach a stable debt level with moderate growth under these conditions. Under the interest rate scenario noted above (let us say with an average interest rate of 3.8% on the new debt) the nominal interest rate would still be substantially higher than the growth rate of the economy. The only way, the nominal debt level could then be kept stationary is by forcing the fiscal balance into surplus. However, the problem is that this affects the denominator in the debt/GDP calculation by sucking out demand (growth) from an economy already structurally impaired (within a currency union and all that).

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The deal which now seems to be close to completed by no means closes proceedings. It is very likely in my opinion that private creditors who are currently the only ones being forced to take a haircut due to seniority of the IMF and the ECB will face a near 100% loss on their holdings. The argument is simple. Given the amount of debt held by the ECB and the IMF and the fact that these two institutions are senior debt holders the debt held by private creditors becomes junior debt and thus the tranche which takes the first (and in my opinion likely complete) loss in the event of a default.

Of course, once we reach this point the issue of CDS contracts will rear its head yet again since if a 50-60% haircut can be considered voluntary anything beyond this becomes very difficult to characterize as such. Any rating agency would find it difficult not to classify further losses as a default and thus begins the fun in earnest. And then comes the ECB and IMF’s share. It will be political dynamite if the ECB had to print on the liability side to cover losses on the asset side on Greek sovereign debt or if the IMF had to ask its contributors for extra cash to cover for losses on loans made out to Greece or any other economy. Obviously, much will be done to prevent this, but just look at the numbers of Greece’s economy and you will see that it is not that outlandish, especially if Greece opts to stay in the euro zone. Finally, Greece only represents the starter here. Any deal agreed to  in Greece will be ardently watched in Ireland and Portugal who will feel they are entitled to the same deal with their private creditors.

Germany Loses Its Grip

By Delusional Economics, Naked Capitalism

Wednesday, January 25, 2012

(I)t is just one symptom of the actual problem. That problem was highlighted overnight with the European flash PMI’s. Germany once again outperformed the rest of Europe, France treaded water, admittedly with its head held a little higher, while the periphery of Europe slowly drifts away. The latest Euro PMI was a little better than expected, in some part due to the ECB’s actions over the last month or so no doubt, put the forward looking indicators suggest more weakness to come and I expect the divide to grow as Europe slows further. As I have stated previously that the German data is a double edged sword because, although it is good for Germany that its economy is powering, it is a big negative for the rest of Europe because one of the major issues that brought on the crisis in the first place was the competitiveness imbalance of nations under the single currency.

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So now even if Greece manages a deal to write-off some of its debt the markets will quickly turn their eyes to Portugal who will no doubt require a second bail out, but increasingly a debt restructure as well.

With Spain also struggling and Italy under increasing pressure, the continuation of contagion appears to be taking its toll on the politics of Europe with Germany’s ability to control the situation diminishing.

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Germany also appears to be losing support from even its strongest allies. Last week the Dutch central banker Klaas Knot gave an interview blaming Germany for the failure of the EFSF.

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To add to that, Luxembourg’s new foreign minister gave an interview with German media yesterday in which he called the fiscal compact a ‘waste of time and energy’.

Is the failure of austerity-centric policy finally taking its toll on Germany’s ability to steer Europe’s response to the financial crisis? This would certainly explain why Mario Monti seems so sure that his country will be receiving the fiscal and monetary backstops. The outcomes from next week’s EU summit will provide more clues.