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Jerks To Get Paid More Than Nice People

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No, not your comp, though probably that too. The Times and the Journal check in today on the state of play in Greece and it's kind of how you might expect. From the Times:

For months now, Greece has desperately been trying to persuade its private-sector creditors that it is in their interest to exchange their existing Greek bonds for longer-term securities and accept about a 50 percent loss as part of the bargain. The negotiations are known as the private sector involvement, or P.S.I.

A few months ago the deal looked doable, as the large European banks that held must of this debt, estimated to be around €200 billion, recognized that it was probably a better alternative than default, which could cost them everything. Moreover, the banks were sensitive to political pressure from their home countries, where they have a big stake in remaining on good terms with the government and key officials.

But as the talks have dragged on, many of these banks, especially big holders in France and Germany, have sold their holdings. Among the buyers have been hedge funds and other independent investors who are now questioning why they should accept a loss, known as a haircut, if, as it turns out, the deal remains voluntary in nature and Greece keeps paying interest on its debt.

And as the number of such hedge funds holding Greek debt has grown, so has their ability to forestall a restructuring agreement, thus bringing them closer to being able cash in on their high-stakes gambit.

From the Journal:

There are many potential pitfalls, each, in a way, leading to another pitfall-strewn path.

Ha! Also ha! on the Times's sort of strange description of what the hedge funds are up to, though what they're up to doesn't itself sound strange. If I were a hedge fund here is what I would do:

1. Not buy bonds and then later "question why I should accept a loss";
2. rather, buy bonds because I plan to get a gain;
3. specifically because I'm planning to be all "oh, man, I must have lost that consent solicitation in the mail, could you send it again" and otherwise generally stall on this voluntary offer until my bonds come due and are paid off with bailout money (maybe?);
4. or, alternatively, because I've got CDS against those bonds and have no intention whatsoever of voluntarily exchanging them and voiding my protection.

That or "stay the hell away from this situation." But, like, the above is at least a strategy. Now, if I were a French or German bank here is what I would do:

1.-4. same;
5. oh, wait, no, I might get some pressure from my regulators/government to play along with the "voluntary" exchange, plus there's some sort of critical-mass issue where if no one does the exchange then things get even worse;
6. hmm, that nice man from a hedge fund is looking to buy my position and he's willing to pay more than this voluntary exchange is offering;
7. hit that.

Amazingly (?) that seems to have been what the French and German banks are doing.

My favorite book about finance, besides the obviousones, is probably Nassim Taleb's juvenilia, back when he was all indie and awesome and hadn't sold out yet.* Here is a thing that he says pretty elegantly:

The most important notion in [he says "option hedging," but you can substitute life with little loss of information] is the contamination principle: ... It means roughly that if there is a possible spot in time and space capable of bringing a profit, then the areas surrounding it need to account for that effect.

So you can, like the Times, say "hedge funds the winners if Greek bailout arrives," and you'd be right. (You can also say "hedge funds the losers if Greek bailout doesn't arrive," and you'd maybe be right, though things like CDS and the fact that there's lots of losing to go around muddy the picture a bit.) But you can also notice that those hedge funds paid out a portion of their probabilistic winnings to sellers like French and German banks, who could probably use a little win right about now. The banks seem to have noticed that, since they hit the bid - and they seem to have thought that it was a better bid than what Greece and Brussels are sort-of-kind-of offering. Compare a maybe 75%+ NPV haircut on even the shortest bonds to this:

So, yes, the jerks - as I've called them, fondly - who don't intend to help out Greece in its time of need may get a nice payoff. Or they may get screwed. But the way they got into that position was by offering a better deal not to evil "hedge funds" but to - well, evil European banks, but still. The fact that the hedge funds stand to - maybe! - get a sort-of-kind-of-windfally-looking profit means that the banks have already done much better than they otherwise would have by the Greek debt exchange.

The banks and the hedge funds get this. A thing to maybe wonder about is the extent to which whoever is corralling the banks - Eurocrats, banking regulators, the IMF, the Institute for International Finance, etc. - also get it. (Probably a fairly large extent, right?) If I were negotiating the PSI on behalf of Greece, I would be pretty pissed if a bank came to me at the last minute and said "nah, I'm not gonna participate in this exchange, just ride it out and see if you default." But I'd be even more pissed if that bank avoided coming to me at all because by the time the last minute rolled around it had already sold to a hedge fund who doesn't care as much about my pissed-off-ness. I'd probably do what I could to make things difficult for that hedge fund. But I'd also think about extracting some pain from the bank.

Well, no, I wouldn't really, because more pain for European banks is the last thing anyone needs. But I'd think hard, now, about providing a currently credible expectation of pain to those banks. Because if on the one hand hedge funds are offering to take their Greek risk off their hands for a price that contemplates a better recovery than those banks could actually negotiate for - and on the other hand Greece/Brussels are offering them nothing to stay in the bonds and the negotiations other than harangues and continental pride - then that does not bode well for the pitfally path of pitfalls.

Hedge Funds the Winners if Greek Bailout Arrives [NYT]

Negotiators Work to Restructure Greek Debt [WSJ]

* This is an amazing book! Just as an aside, if you enjoy the ... maybe somewhat off-putting picture of Taleb's personality that you can get from some of his pop books, there are moments of bliss here. Try the first page of Dynamic Hedging: "I clambered up to my attic where, during 6 entire months, I spent 14 hours a day, 7 days a week, immersed in probability theory, numerical analysis, and mathematical statistics (at a Ph.D. level. Then I began to write this book." Thanks! It's really great though.


So Maybe Greek CDS Will Be More Than Fine?

Gaaaaaaaaaaaaaaaah Greece. Okay so all systems appear to be go on the Greek debt exchange, which means its time to decide What This Means, and, I just. Really. Greece. Come on. All I want is to talk about 13D reporting requirements, and now I have to pay attention to Portugal? No. Just no.* Still here is arguably a fun factoid: On Wednesday, Swiss bank UBS AG started quoting a "gray market" in new Greek sovereign bonds ... using as a guide details of the debt swap Greece has put on the table for private investors to accept until Thursday evening. The "bid" price for a batch of future Greek bonds due in 2042, or the highest price the dealer was willing to pay, was around 15 cents on the dollar; the "offer" price, or the most the dealer was willing to sell at, was 17 cents on the dollar, the first person said. ... The prices quoted by UBS imply that losses private creditors to Greece will take are more like 79% of face value, not the original haircut of 70-75% many had expected. Yeah but. If you believe this horrible CDS mechanics stuff that various people including me have been yammering about for weeks - here is the best explanation - that means that if for some reason you had the foresight to be long Greek bonds and hold CDS against them you'd end up with a package worth (1) 21 on the bonds and (2) 83 on the CDS (assuming that the 17 offer for the 2042 bonds represents a real price for the cheapest-to-deliver new bond in the Greek auction) for (3) 104 total which is (4) more than par, so you win this particular game, yay. Which you were at risk of losing - a week ago one of our fearless commenters spotted the longest new bonds at 25ish vs. 24ish for the old-bond-y package, for a total of 99 for the hedged holder - losing 1 point versus par.**

This Is Really Only The "Second" Greek Bailout?

If you're into Greece you've probably already read all about it and if you're not I can't make you. But in brief: Greece is fixed and we will NEVER HEAR ABOUT ANY PROBLEMS EVER AGAIN. In less brief: (1) Some folks stayed up all night and produced a statement. (2) Greece's private creditors will be offered the long-anticipated opportunity to voluntarily exchange their old bonds for new bonds, which will for the most part be the same as the old bonds except for minor differences including but not limited to a greatly extended maturity (to 2042), a 53.5% reduced face amount, and a 3.6% blended interest rate. (3) If they don't voluntarily exchange, which they will because - hilariously - they've already taken accounting writedowns (and also because I guess it's better than a disorderly default), private holders will get CAC'ed, which may or may not be as bad as it sounds, but in any case at least CDS will pay out, unless it doesn't. (4) Also the public sector will do various helpful, confusing things. (5) In exchange for this, Greece will enact horrible austerity, and because no one believes that Greece will actually do that, there will be escrow accounts and what Reuters ominously calls "permanent surveillance by an increased European presence on the ground." (6) Everyone is pretty sure we'll be doing this again in six months and, look, just fair warning, I will not be writing about it then, because feh. We haven't had a serious international bankruptcy, which this pretty much is, since I started paying attention to the financial markets, two months ago, so I mostly think about insolvency from a US bankruptcy law perspective. One thing that happens in bankruptcy is that, like, really really roughly speaking, the creditors stop being creditors and become the owners. This isn't always the case but the basic playbook of US bankruptcy law is: