Failure of Greek debt deal could cost $1 trillion!
Decision day for the Greek debt crisis is drawing near, and insiders are predicting that if things go awry it could cost the world economy $1 trillion.
Greece’s credit rating was cut to selective default by Standard & Poor’s after the bell on Monday, reflecting the implementation of collective action clauses (CACs) on its debt. Greece is in the middle of one of the largest sovereign debt restructurings ever and needs to secure significant private sector participation rate; CACs are designed to forcibly increase that rate.
According to S&P, the Greek government retroactively inserted CACs into the documentation of certain series of its sovereign debt on February 23, two days after the Troika agreed on the terms for a second bailout package. This retroactive implementation substantially changed the terms of the deal and diminished investors’ bargaining power in the face of a restructuring, causing the downgrade, S&P said.
Greece needs to fulfill certain conditions in order to receive the next tranche of money and avoid a disorderly default. Among those is the successful implementation of the so-called PSI (private sector involvement) deal, which is supposed to be voluntary. In practice, Greece is executing a bond restructuring that will see bondholders take an approximately 70% haircut on the net present value of their bonds while the average maturity will be significantly extended, reducing shorter-term funding requirements.
For the PSI to succeed, the Troika (made up by the EU Commission, the ECB, and the IMF) is expecting Greece to secure the participation of 95% of private bondholders. Experts at Barclays believe Greece could come short, and thus would use retroactive CACs that could require a 66% participation rate to force all bondholders to take the deal.
“In our opinion, Greece’s retroactive insertion of CACs materially changes the original terms of the affected debt and constitutes the launch of what we consider to be a distressed debt restructuring,” read S&P’s post-market release.
Consummation of the debt exchange would result in a credit upgrade, S&P announced, and would take Greece’s credit rating to CCC. “In this context, any potential upgrade to the ‘CCC’ category rating would reflect our view of Greece’s uncertain economic growth prospects and still large government debt, even after the debt restructuring is concluded.”
A failure to secure a high enough participation rate could well lead to an outright default, S&P warned, given the Hellenic Republic’s lack of access to capital markets. Bondholders have until about March 12 to participate, according to S&P.
Greece faces a hard deadline of March 20, date when it is scheduled to pay €14.5 billion in bond redemptions. On Monday, German members of parliament passed a bill approving the second Greek bailout. After Angela Merkel’s victory at the polls, investors will have to keep their eyes on Dutch and Finnish parliamentary votes on the bailout.
In a confidential memo that has just surfaced, the industry group representing bond holders has said that the consequences of such a default could be $1 trillion in losses. “When combined with the strong likelihood that a disorderly Greek default would lead to the hurried exit of Greece from the Eurozone, this financial shock to the [European Central Bank] could raise significant stability issues about the monetary union,” the International Institute of Finance’s memo said, according to a copy posted on a Greek news website.
Even with the potential damage, it is not clear if all the bond holders will sign on, and Greece said it will only go ahead if it gets 75% participation. Many of the bonds are currently held by hedge funds who bought them up on the cheap and who are now disappointed with the level of the cuts that Greece is insisting they take. The IIF put out a statement Monday listing all the bond holders who are willing to take the deal.
Bloomberg estimated that they only account for 20% of the total participants needed. Greece’s finance minister told Bloomberg Television this is the only chance bond holders will get. “This is the best offer because this is the only one, the only existing offer,” Evangelos Venizelos said.
If they don’t take it, today’s stock market declines are going to look like small potatoes.