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Europe Decides…Something


The crisis in Europe has been stunningly reversed, or so the markets think. Details are sketchy but we have this:

Banks and other holders will voluntarily take a 50% hit on Greek bonds. That is, if they have a face value of 100 euros, they will get back only 50 euros. Consider then that many of these bonds were trading at 30 to 40 cents to the euro, meaning a print of 50 is actually good for the banks. Still, many banks have not marked these bonds to market because of insane EU rules that allow them not to.

Why “voluntary”? Germany was insisting on a 60% haircut but banks didn’t want that. This wasn’t too much of a negotiation – Greece, without a bailout, would have destroyed themselves. And then, the haircut didn’t apply to non-private entities (like the ECB). The reasoning is simply that no one wanted to trigger credit-default-swaps. CDS on the Greek bonds will not be triggered if the nature of default is voluntary. And ISDA has confirmed that.

Why should the CDS not be triggered? Many of the banks had written CDS on Greek bonds and if they had to pay out on those claims, they would certainly be bankrupt, which is  your Lehman all over again. Still, Greek CDS is not quite that much in size – the fear now is, if such a small CDS amount trigger will cause banks to poop in their pants, what happens when the size of a Spain or Italy start to get shaky?

Also, this is a scam of incredible proportions. If you owned bonds and had bought CDS as “protection” – you have NO protection. This is not a “trigger event”, meaning the person who sold CDS doesn’t have to pay up. (You buy CDS by paying say 500,000 for $10 million worth of bonds. If there is a “trigger event”, the buyer pays up the default value; a 50% haircut means he would have to pay $5 million) Effectively, the EU region worked together to ensure that CDS protection was not provided, adding substantially.

Second: the idea is so that Greek debt to GDP is 120% by – and this is where I was shocked – 2020. That’s nine years away. They want to achieve a debt ratio that is ludicrously large – 120% – in nine years? That, after a 50% haircut on existing debt? With all the austerity in the world? Just how much shit were they in?

Third: Since banks will be undercapitalized after the haircuts, the idea is to use Euro money to support them, through the EFSF. Banks should first try to approach private sources of capital, then their own countries, while restricting bonuses and dividends. Only if none of this works can they go to the EFSF.

Finally, the EFSF itself may be levered up from the $440 billion euros proposed, by using it to provide insurance to bonds.  This could multiple impact by 4 or 5 times.

The rest is just a promise that everyone will work together. That, we’ve heard before.

Is this a good plan? US stocks went up 3% , while the CAC and DAX up over 5% each yesterday. India was closed and has opened up 3% today. The US had more reasons for Euphoria – their GDP showed a print of 2.5% yesterday. I don’t think this is a great statement by the European Union in general, but hey, prices are the king and prices are telling us otherwise.

I’ve had to exit short positions across the board – most were out on Monday, a couple remaining today were exited. Now to take the long signals – already, some of the longs are up 4 to 5%. It’s a strange market.


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