The media and some pseudo-analysts, and, surprisingly, even some investors, still don’t understand what the 21 percent haircut in the Greece bond restructuring is all about. The 21 percent touted about is simply the hypothetical secondary market discount of the various bond options assuming they trade at a 9 percent Greek sovereign yield. This is totally arbitrary as it is unlikely that the new bonds will trade at a 9 percent Greek yield. Nevertheless, this is where the banks are writing down or reserving against their Greece exposure – 79 cents on the euro.
It is NOT – we repeat NOT — the amount that Greece will have its debt reduced. In fact, using the first term sheet of the Institute of International Finance, the actual debt reduction Greece would secure, on a present value basis, is only about 6 percent.
The follow-up term sheet stated the interest rates on the new bonds would not be set until the deal was ready to close and the coupon rates would be determined to insure the present value of the new bond, discounted at a 9 percent Greece sovereign yield, would be equivalent to 79 percent of face value – that is, a 21 percent discount. With the spike in the value of the zero coupon bond collateral, these interest rates will be much lower than those of the first term sheet.
Therefore, Greece and the EU do not yet know the amount the debt will be reduced under the PSI deal. Furthermore, the collapse in long-term yields will add around Euro 8 billion to the cost of the zero coupon bond collateral which will back the new bonds. Greece will now have to borrow around Euro 50 billion from the EFSF to close the deal, while only reducing its bond debt by a de minimis amount.
No wonder there is talk in Europe of reopening the terms of the deal, which the banks adamantly oppose. The ambiguity over such a simple term “haircut” with respect to Greece is emblematic of the Eurozone’s leadership and political problems. We are not certain if each member understands the difference between a haircut on banks balance sheet versus debt relief granted to the country.
Most of the commentators on CNBC do not. Does Merkel, Sarkozy, and Trichet? Surely Trichet must. Like JP Morgan during the 1980’s, who had reserved 100 percent on the LDC Debt portfolio before granting debt relief to the countries, the banks can take a 50 percent haircut by writing down or reserves their Greek exposure by 50 percent and still not grant 1 cent of debt relief to sovereign government, which is not far off from what they have attempted in the current bond restructuring or PSI deal.
So what does it mean to say Greece needs a 50 percent haircut? Is it the banks need to write down or reserve against their Greece exposure by 50 percent or does it mean the banks and bond holders need to reduce Greece’s debt stock by 50 percent? If it is the later, the new new bonds will trade much lower than where they are today unless they are backed by the 30-year zero coupon bonds in the original term sheet.
It is clear, at least to us, and we could be wrong, the Greeks didn’t have a seat at the table when negotiating the terms of the PSI deal. Welcome Neocolonialism 2.0.