Greek Haircuts: A Clarification

By Global Macro Monitor

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 rates would be set to insure the present value of the new bond, discounted at a 9 percent Greece sovereign yield, would equal 79 percent of face value – that is, a 21 percent discount. With the spike in the value of the zero coupon bond collateral, the interest rates will be much lower than those of the first term sheet.

Therefore, Greece and EU doesn’t yet even 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 only a de minimis amount.

No wonder some Europeans are talking of reopening the terms of the deal, which the banks adamantly oppose.

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