The nature of today's Greek default

21 Feb 2012 by Jim Fickett.

Part of the Greek bailout deal agreed today was a restructuring of debt held by private parties. Although this was described as “voluntary”, it was really, of course, a partial default. Since many other nations have unsustainable debt, it is worth seeing how this potential precedent was structured. The Financial Times reports:

the [face value] haircut investors will have to take was increased from 50 to 53.5 per cent in the early hours of Tuesday morning after more than 12 hours of negotiations. …

The latest official debt sustainability study on Greece assumes 95 per cent of investors will participate in what is being sold as a “voluntary deal”.

In private, large bondholders say the take-up is likely to be high, if only because the alternative of a full-blown Greek default is so bad. But none are willing to guarantee a participation rate, which will depend on Greece’s ability to squeeze investor holdouts through collective action clauses.

These allow the decision of a supermajority, often about 70 per cent, to be imposed on all other investors.

“This deal is clearly at the absolute limit of what can be called voluntary,” said one large European bondholder. …

The bond swap would eliminate €100bn in Greek debt if all of the estimated €200bn in private holdings takes part in the deal, due to close in mid-March ahead of a large Greek bond redemption on March 20.

Bondholders will receive new debt with substantially lower interest rates of 2 per cent for the first three years, 3 per cent for the next five, and 4.2 per cent after that. Analysts estimate the net present value loss for investors will be close to 75 per cent.

But some investors are playing up parts of the deal that would allow them to benefit from any recovery in Greece.

Mr Dallara [chief negotiator], talking about growth trackers that would pay higher interest rates in the case of stronger growth, said: “I may be in the minority but I think Greece can pull it round. No sovereign has had €100bn lifted off its back in a couple of weeks and this has just happened.”

[Emphasis added]

So investors are having their arms twisted to participate, and will lose, through a combination of writedowns in face value and below-market interest rates, about 75%. Keep that in mind as other sovereign debt dramas unfold.