Greek Debt

With just 50 days left until Greece’s March 20th bond series repayment of $18.5B becomes due, the future of the Eurozone remains unclear.  The unofficial deadline for reaching an accord (January 30th) has come and gone, leaving little time for administrators to manage the logistics of what deal may come.  Amid intense negotiations, the region remains stymied as a changing set of potential outcomes take shape.  Recent progress (or lack thereof) has heightened the probability that one of the following will take place:

Base Scenario:  Voluntary Acceptance of the Proposed Write-Down

Before other Eurozone countries will consider some $169B in additional aid, Greece must first strike a deal with bondholders.  The proposal (a 50% write down which could lower the effective value to closer to 30% after all conditions are met) has seen much discussion but no mutual consent.  The sticking point?  Not only would private investors be forced to take a 50% loss on the face value of the bonds, the coupon would fall to 4% and the payback date would be pushed farther into the future.  Yet it’s not just a matter of getting faceless investors to take a loss: conflicting bondholder incentives muddy the waters.  Major players including BNP Paribas, Commerzbank, ING, and Deutsche Bank must strike a balance between recovering capital and simultaneously playing a role that protects national and Eurozone best interests.

Scenario #2:  Forced Acceptance of the Write-Down

Greek Prime Minister Lucas Papademos told the New York Times that he would “consider legislation forcing the creditors to take losses on their holdings if no agreement [could] be reached in critical negotiations” (this, presumably to entice private investors to go ahead and take the package.)  Though the Greek government would likely seek to enforce terms similar to those seen under a voluntary acceptance scenario, the value of the bonds would continue to fall.  For one, it will signal unprecedented desperation—a lack of internal (to Greece) confidence that a fairer and more favorable deal with investors could be fiscally honored.   Private investor steadfastness that would lead to such a measure would also signal an escalation that further weakens the position of Greece.

Scenario #3:  Default

If it becomes clear that the March 20th date will come and go with no accord, as of that date, Greek bonds will be in default.  Enter a new set of stakeholders: investors who bought Credit Default Swaps (CDS) that will pay out if a technical default occurs.  In that case, Greece will be further downgraded (raising their future cost of borrowing) while bondholders will attempt to recover whatever portion of funds that they can.  While some CDSs are held by original bondholders who purchased them as a hedge, a separate group of stakeholders with no ties to the original bonds are hoping to see a technical default occur (effectively, Greece has already defaulted by admitting that it can’t pay back principal or coupon on time and asking for a write-down; however, it won’t be considered a default, or trigger CDS payouts, if a write-down deal is made).  Worst off in this scenario are bondholders who sold the hedges, who will be on the hook to pay out for the hedges while simultaneously taking a loss on the primary investment.

The Real Story: The Aftermath

More important than the $18.5B in bonds at stake is what will happen whether any deal is made or not.  Even Greece’s best case scenario (to strike a deal with bondholders and receive additional EU aid) comes with strings attached—namely measures to bring in fiscal managers from neighboring countries, which some say call into question Greek sovereignty.  A worst case scenario (default + denial of additional aid) would bring Greece to its knees, initiating a chain of events that may have the greatest impact seen to date.  Heavier questions around Greece’s continued Eurozone participation and viability as a sovereign nation (not to mention the magnitude of effort required to extricate Greece from the Union) may pale in comparison to the context of the greater market.