Today we heard that talks between the Greek government and its creditors are close to a total breakdown, which Greece warns could have catastrophic results. The Greek government is looking for a “50 percent haircut” in the principal owed to its debt holders. The debt holders would be paid a small amount of cash and given new debt that would represent approximately 50 percent of the total owed. Most creditors are OK with that, but are concerned that the interest rate being offered on the new debt is not high enough to reflect the risk of future financial problems. Greece’s position is that it needs to reduce its overall debt service amount, a coupon rate under 4 percent, so that it can revive its struggling economy.
Greece has assured its European counterparts that it will be successful in achieving the haircuts from debt holders, a prerequisite to receiving the next tranche of bailout funds. The immediate issue is that Greece has a 14.5 billion-euro payment to bond holders due on March 20. The paperwork on any deal is expected to take up to six weeks to complete, giving them a short timeline to strike a deal.
Making matters worse is that enough of the debt is collectively held by hedge funds that could scuttle any type of deal. Most of these funds have also purchased CDS insurance (credit default swaps) that will pay them 100 percent on the euro if even a technical default results. Albeit, you know that their claims will end up in a lengthy court battle necessitating the hiring of good and expensive law firms. Most of the funds are being quiet about their intentions, but one was quoted, “I think we’ll hold out.” (CDS payouts were a major factor in the failure of AIG Insurance. AIG did not have enough collateral to back up the claims from debt defaults.)
Most of these funds bought their positions at anywhere from $0.20 to $0.45 on the euro, so at a 50 percent cut, they still make money depending on the interest rate and maturity date on the “new debt,” i.e. the time-value of money.
With today’s downgrade of France’s debt from the coveted AAA rating and other European countries experiencing downgrades, we are long from resolving the European credit crisis. Stay tune for updates.