Greek CDS: No Soup For You!

So the most interesting story today is that the Eurozone has “cajoled”  bondholders into accepting a 50% haircut on their Greek debt positions.  The offshoot to this is that, according to ISDA rules, this means that Greek CDS will NOT be triggered – as voluntary restructurings do not constitute a credit event.   I don’t really know how “voluntary” “cajoling” is, but let’s move on.  Greek CDS holders were essentially told: NO SOUP FOR YOU!



The Unintended Consequences Machine could really get churned up as a result of these actions.  Consider:  if CDS contracts don’t provide the protection that they are intended to provide, then shouldn’t bond buyers now be less willing to extend credit which they can’t hedge?  In other words, previously a bank could buy Greek bonds and Greek CDS and sleep tight – but now they know that they can get their arms twisted by political leaders and/or the ECB, to “voluntarily” restructure bad debts,  leaving their “insurance” worthless.

Note that this might not be a bad thing:  as we saw in both the American and European financial crises, easy credit was provided by those who thought they had little/no risk because they were “hedged.”  By now you should know the rest of the story – credit orgy, unpayable debts, yadda yadda yadda.  The result of reminding lenders that they have real, un-hedgeable risk* is likely to be higher borrowing costs and, hopefully, more prudent lending – and even though that may be “for the best” in the sense that it might help to prevent a further credit orgy and subsequent financial system implosion (AGAIN!), it has its own real effects on the current economic environment.

I need someone to explain to me what happens to bondholders who say “NO” to the restructuring plan.  What happens to “holdouts” who refuse the Offer They Can’t Refuse?



Or is it that the ECB will now become the de-facto provider of all CDS (of course, it won’t be called CDS – I just mean they’ll backstop losses) – providing rescue packages to financial institutions who lose money on these “restructurings” ?


EDIT: ISDA has put out a Q&A.  please  note:

“If a creditor is hedging using CDS, and declines to participate in a voluntary restructuring, then the creditor would still hold its original debt claim and its CDS hedge, which would continue to protect against future non-payment or a mandatory restructuring for the remaining term of the CDS.”

So, correct me if I’m wrong, dear readers, but wouldn’t anyone who has a “hedged” position thus decline to participate in the debt restructuring?   Why take a haircut if you’re “hedged” ???   And how does ISDA differentiate between participants and non-participants in the restructuring?  They classify each CDS holder as “participating” (ie: worthless) or “not-participating???  What happens to CDS sellers who hedged by buying back the CDS from a different counterparty, but don’t have an underlying bond position?

EDIT II: Here’s the important point with respect to Greek debt and Greek CDS, which explains why in this specific case this may be a case of My Big Fat Greek Much Ado About Nothing: Net Greek CDS outstanding is under $ 4B.  (NET is defined as: “Net notional positions generally represent the maximum possible net funds transfers between net sellers of protection and net buyers of protection that could be required upon the occurrence of a credit event relating to particular reference entities“).  Now FT Alphaville has a relevant post today, as does Matt Levine at Dealbreaker.   I gained some clarity by asking questions to someone who knows much more than I do about this subject: Alea, on Felix Salmon’s comment thread.

The bottom line is that the market setup in the Greek debt situation is NOT like I illustrated above in this post: ie, lenders buy Greek debt and hedge with CDS – that’s NOT the alignment.  We can tell this by looking at the net CDS notional number (small: $ 3.7B – and yes, there’s always the possibility that this number isn’t totally accurate).   Also, those who are long Greek debt and long CDS protection don’t have “worthless” protection – they can hold their old Greek debt (ie, decline to participate in the “voluntary” restructuring), and hold their CDS, and collect (attempt to, at least) if/when Greece actually does default on that debt.

The Alphaville piece addresses the issue of net vs gross CDS issuance, and the potential for contagion issues even with smaller “net” numbers.   Alphaville notes, however,  that these Greek CDS trades are collateralized, a point which Alea also echoed.  I mentioned that I think that the problem that us non-experts in CDS intricacies have is that we confuse this with the AIG 2008 situation.  That was a very different situation – huge net CDS exposures which were largely uncollateralized – leading to monstrous contagion risks when things went bad.



* Note that on a systemic basis, “risk” isn’t really hedgeable either, which was precisely the problem leading to the US Financial crisis.    When everyone buys insurance from the same guy (Let’s call him AIGiie), it doesn’t eliminate the risk from the system! (EDIT: but that’s NOT what we’re talking about here – the NET CDS notional on Greece is actually very small. As I mentioned above, I think that many non-expert observers, myself included, erred in thinking that this was like the U.S. 2008 AIG situation with respect to the CDS exposures.)

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