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Sunday, 15 January 2012

How far unsolved repayment of Greece's debt lead? Straight to the abyss

 

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A joint EU’s and IMF’s financial support similarly imposed even higher burden to Greece. A €110 billion EU/IMF bail-out package agreed in May, 2010 followed by the Eurozone’s €12 billion bail-out package in June, 2011 and extra €109 billion support in July, 2011 were agreed in exchange of accepted severe austerity measures those involved spending cuts, tax increases and privatization of public assets. Passed proposed measures without taking a recovery plan into consideration shrank Greece's economy into deeper recession.

According to the remarks mentioned at the IMF’s conference called on Greece in December 13, 2011, the representatives of the mission revised the Greece’s GDP growth down to -6% in 2011, and -3% in 2012. So, could anything worse be expected than deteriorated Greece's economy and increased Greek default probability?

Credit Default Swaps were invented by Wall Street as credit insurance to reduce risks and facilitate issuance of debt securities. However, it may appear that banks, investment banks or hedge funds those issued the Greek Treasury CDS do not have enough collateral to compensate the insured for his loss if Greece default on its debt. If the above is possible then a voluntary private sector involvement in 50% nominal haircut proposed in October 2011 may also be treated as an agreement designed to avoid the collapse of insurers. It is expected that voluntary accepted write-down of Greek debt will not trigger CDS compensation and at the same time will reduce the Greece's sovereign debt by €100 billion. An extra €100 billion support to Greece could reduce its debt to 120 % of GDP till 2020.

However, the success of such agreement which is aimed to minimize losses depends on the proportion of Greek bonds holdings and issued CDS. According to the information published at the New York Times in January 10, 2012, it was estimated that a few months ago about €200 billion of Greek bonds were held at large European banks. But as talks have dragged on, many big holders in France and Germany sold their holdings to London Hedge Funds and other independent investors. Hence, a voluntary private sector agreement to accept a 50% haircut may be harder to achieve if an entity which possess Greek bonds is not an issuer of the CDS?

On the other hand, if an agreement of a voluntary 50% haircut is available then what a purpose and a future of the credit default swaps? According to the BIS quarterly review issued in December, 2011, a notional amount of outstanding credit default swaps was $32.4 trillion in June, 2011 with a gross market value of $1.35 trillion.