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WTF: Greek debt vs. CDS

January 27, 2012

Just to be clear, if I’m a hedge fund who owns Greek bonds right now, and say I’ve hedged my exposure using CDSs, then why the fuck would I go along with a voluntary write-down of Greek debt??

From my perspective, if I do go along with it, I lose a asston of money on my bonds and my CDSs don’t get triggered because the write-down is considered “voluntary”. If I don’t go along with it, and enough other hedge funds also don’t go along with it, I either get paid in full or the CDSs I already own get triggered and I get paid in full (unless the counterparty who wrote the CDS goes under, but there’s always that risk).

Bottomline: I don’t go along with it.

None of this political finagling will change my mind. No argument for the stability of the European Union will change my mind. In fact, I will feel like arguing, hey if you force an involuntary voluntary write-down, then you are essentially making the meaning of CDS protection null and void. This is tantamount to ignoring legal contracts. And I’d have a pretty good point.

How’s this: let this shit go down, and start introducing a system that works, with a CDS market that is either reasonably regulated or nonexistent.

In the meantime, if I’m a Greek citizen, I’m wondering if I’ll ever be living in a country that has a consistent stock of aspirin again.

Categories: finance
  1. Deane
    January 27, 2012 at 9:43 am

    “start introducing a system that works, with a CDS market that is either reasonably regulated or nonexistent” Amen!

  2. vbounded
    January 27, 2012 at 9:48 am

    Cathy, the kicker is that if you have a duty of loyalty and care to your investors, and if you breach those duties by failing to reject a voluntary haircut, you get sued by your investors and lose your house.

    Greece can try to force a haircut because like 90% of its bonds are governed by local law. But investors can fight if they’ve got a good treaty …

  3. January 27, 2012 at 3:11 pm

    And just to make matters worse although a genuine default still f***s up Europe, the ECB and the Greek private banks, a default is no longer directly bad news for the Greek government, because the austerity measures have worked and they now have a surplus (prior to interest payments) http://www.bbc.co.uk/news/business-16756135

  4. PragmaticLibertarian
    January 28, 2012 at 12:39 pm

    I’m not sure that the CDS should be a problem in the way you are suggesting. While it is true that the hypothetical hedge fund will not agree to a writedown because it is insulated from the costs of default, those costs have been transferred to the CDS seller, not eliminated. Accordingly, it should be possible to bring the CDS seller into the negotiations and have the situation be the same as if they (and not the hedge fund) were the owner of the bond – because economically they are.

    The real reason the talks are failing is not that owners are insulated due to CDS purchases, but that the Greeks (and more relevantly the Germans and the ECB) want private sector bondholders to bear the entire cost while public sector owners are not harmed by the restructuring. This can only be accomplished voluntarily and will hurt private sector owners more than a default. This, and not anything to do with the CDS market, is why the negotiations have failed.

  5. Aloysius
    January 28, 2012 at 5:25 pm

    One question that is becoming pertinent is: who are the CDS sellers? One reason this is important is that, in case of a Greek default, some CDS sellers might go bankrupt under the weight of their obligations. This is what happened in the housing crisis, e.g. AIG, the largest guarantor of such insurance, collapsed. I have been told that, in that case, the ECB and the governments who hold Greek bonds are going to re-negotiate the bond terms, while private investors will be allowed to neither contest the terms, nor take recourse to either veto what the ECB and the Greek government negotiate or sue the Greek government. That is the worst possible scenario for a private investor, and the scenario with which the Greek government and the EU might be threatening private investors. That would be a strong incentive for hedge funds to participate in the negotiations.

  6. ZObserver
    January 30, 2012 at 10:18 am

    You make a great point here. I wonder who are the counterparties that have to pay up on Greek CDS. Jamie Dimon said that he believes US Banks have very little exposure to Greek default. Since AIG is out of the game, who in the world is stuck with this exposure. The hedge funds you mentioned bought the insurance from someone…or is this a hallucination in a CDS environment that lacks transparency. Maybe we will find another MF Global on the end of this line.

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