A bad haircut

By Warren Mosler, an investment manager and creator of the mortgage swap and the current Eurofutures swap contract and Philip Pilkington, a journalist and writer based in Dublin, Ireland

Are these haircuts on Greek debt really such a good idea? Or are they really just a stopgap that will make things all the worse in the long-run?

Sure, Mr. Market seems to think they’re fantastic. But then, Mr. Market has always been about as easy to please as a rather stupid dog: give him a car to chase and he’ll be happy – until his nose inevitably meets the bumper, of course. After all, these are the same markets that rally every time the Fed or the Bank of England announces more monetary voodoo ala QE.

As many of us have been saying time and again, the situation is simply not sustainable until the ECB takes up its proper role and backstops all the wayward debt. Until then, the whole thing will continue to resemble a man trying to lift a bucket by the handle while he stands on it. He might make a lot of noise and attract a lot of attention, but he’s not going to get anywhere.

There are any number of reasons that these haircuts will not work.

First up, there is still the implicit assumption that once the haircut is taken the Greek deficit can be brought under control. The recently leaked document from within the Eurostructure was sceptical of this, but even that document was overly optimistic as far as we can see. With the levels of unemployment that Greece continues to suffer – levels that will probably rise in the near future – those deficits are here to stay.

Then there’s the issue whether or not haircuts of 50% will be considered sufficiently voluntary. Not to mention the assumption that private sector funds will recapitalize the banks that lost capital on the write downs.

But the real elephant in the room – nay, it’s more like a mammoth – is the assumption that these haircuts will not cause other Eurozone countries bond yields to rise, thus requiring further intervention by the EFSF and, most likely, the ECB.

Think about this. You’re a private sector institution that has to ensure that you don’t take losses on crappy paper. You’ve now seen that the Eurocrats are willing to burn anyone who invests in the sovereign debt of any European country that experiences significant financial difficulties – difficulties which, it should be pointed out, are imposed on these countries by the Eurocrats. And you’re expected to continue to consider, for example, Italian debt to be relatively safe? What a lark!

The Eurocrats are essentially telling those who invest in the sovereign debt of European nations that they are expendable and open to taking massive losses should political whims lead the Eurocrats to further wreck the region’s economies and systems of government finance. Good marketing plan, folks! Keep it up; soon you’ll have scared all your customers away! Who knows, maybe it’s all a big Halloween prank!?

We can expect that the ratings agencies should catch up to this not so subtle point soon. Then the conditions for a perfect storm will be in place and yields will start to climb on the government bonds of various European countries. This will then require further bond buying from the EFSF and ECB.

This, of course, is probably the direction in which the whole thing is headed. But it’s going to take a long time to get there and it’s going to carry with it a whole lot of unnecessary pain for a whole lot of people.

  1. blankfiend says

    Many questions:

    1. What will the discount rate be for this “voluntary” notional value write-down? If it seeks to preserve NPV, might not do Greece much good.
    2. Will rating agencies see this as voluntary?
    3. If CDS hedges are no longer useful protection on sovereign debt, do you reduce your holdings of that debt for other Euro-soverereigns?


  2. Stevie b. says

    Well, I hesitate to argue with people who are undoubtedly my superior when it comes to this sort of thing (and I’m not being sarcastic), so maybe someone can please tell me where I’m going wrong here, cos I must be misunderstanding something(s).

    Since when was bond investing risk free?

    Since when was 1 country’s debt guaranteed by another?

    Since when were the yields of all euro-countries equal at equal points along the curve? Obviously they’ve been different – and for ruddy good reasons!

    Since when was sovereign debt guaranteed against failure?

    Surely the point is that investing in individual euro-country-bonds is not a risk-free endeavour, is it?

    The banks should thank their lucky stars (again) that the haircut’s only 50%. Does this not mean that the taxpayer/pensioner pays again one way or another to keep the 1% in la-la land? They made their investment choices – they need to live with the consequences – which should at the very least mean their own unemployment.

    1. fresno dan says

      I agree completely with you.
      When you succeed, you get the profit, and when you fail, you take the loss.
      I must have been taking a nap when they changed capitalism from a profit and LOSS system to a PROFIT and ONLY PROFIT system.
      Uh, when do I get my trillion to “invest” and never lose any money…?

  3. Rp says

    Greece has 350bn of debt. The banks own 78bn of which the Greek banks own 47bn, leaving 31bn with non Greek banks. The rest is held by insurance companies, hedge funds, mutual funds etc. Why is everyone excited about banks taking 50% haircut when it will only amount to 15.5bn (ie. Note you should not count the Greek banks bond holdings)?
    Why would a hedge fund agree to this deal? They won’t. Difficult to see CDs not being triggered here (not that I have a big issue with that).
    Lastly, just wait for the sovereign credit rating downgrades across Europe now that the agencies have a higher LGD to work with.

  4. jk says

    French banks are more exposed to Greek default risk than Germany. 50% haircuts to all bond holders therefore effect French banks the most. They had a spike of investor confidence today but when the lights go on, the mess, regardless of Chinese assistance to the EFSF (as a market protection measure certainly)won’t help. It simply isn’t enough money. Oooopa!

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