Things are really getting Alice in Wonderland in Europe now. Tragedy is rapidly morphing into farce.
The latest burst of optimism — born of a supposed get together between Merkel and Sarkozy — is exhibit A as to why “rational economic man” is a completely mythical creature.
How many times now have investors swallowed euro politicians’ promises that a “solution is imminent?” Half a dozen? More?
But this latest jab takes the cake, as France and Germany try to engineer a “voluntary” creditor participation, i.e. a default that doesn’t count as a default.
From the New York Times:
Germany backed away Friday from a confrontation with the European Central Bank over a new bailout package for Greece, agreeing under pressure from France not to force private investors to shoulder some of the burden.
…Chancellor Angela Merkel and the French president, Nicolas Sarkozy, announced their agreement after a two-hour meeting in Berlin.
“We would like to have a participation of private creditors on a voluntary basis,” Mrs. Merkel said at joint news conference with Mr. Sarkozy.
“This should be worked out jointly with the E.C.B.,” she added. “There shouldn’t be any dispute with the E.C.B. on this.”
So let me get this straight:
- The new hope is for private creditor participation on a “voluntary” basis, i.e. a default without a default.
- If private creditors “agree” to let the maturity of their Greek holdings be extended by X years or what have you, then the “D” word — default — can be avoided, and thus we get a restructuring without the nastiness of meltdown.
First, good luck convincing those creditors to go in for a “voluntary” haircut.
Second, were the eurozone to actually be successful in engineering a “default without a default,” what the hell happens to the CDS (credit default swap) market? Wouldn’t this move render the whole concept of CDS insurance pointless?
European Central Bank chiefs are determined to ensure any Greek debt restructuring won’t be deemed a credit event enabling buyers of protection to seek compensation from swaps sellers. It costs $2 million annually to insure against Greek default for five years, with Portuguese and Irish swaps also seeing all-time high prices.
A debt restructuring that doesn’t trigger swaps would be more damaging to the market as it would devalue contracts, according to analysts at JPMorgan Chase & Co. and Bank of America Merrill Lynch. Such a move would leave banks with unprotected, or unhedged, holdings, forcing them to sell bonds and ultimately drive sovereign borrowing costs higher.
So okay, summing up again:
- The new ingenius plan of Sarkozy et al — with Merkel being hammerlocked into queasy semi-agreement — is to jury rig a “default without a default” so that the shiny happy charade can keep on.
- But if they pull this off, the banks holding PIG liabilities are still screwed because investors are smart enough to figure out the “non-default default” is still an ACTUAL default — and now the banks’ disaster insurance (in the form of CDS) is possibly rendered worthless!
More from Bloomberg Businessweek:
“We have absolutely no experience as to what may happen if a member of a unique monetary union such as this one were to take such a step,” Juncker was quoted as saying. “The risks are so big that I can only warn of such a move.”
“The holy grail is to find a way in which to involve private sector participation, but without triggering a default,” said Harpreet Parhar, a strategist at Credit Agricole SA in London. “I don’t see how that’s possible.”
In other words, “There is pretty much no damn way to pull this off, and it might be like pouring kerosone on a fire, but hell, we’ve got nothing else to try…”
Yeah, way to go guys. And way to go Mr. Market for getting “optimistic” yet again (we’ll see how long it lasts).
The near ‘breakthrough’ hinted at by Sarkozy et al sounds more like a Rube Goldberg contraption than an actual viable plan — it’s not a default, it’s a gentlemanly whoozawhatsit!
And even if the “non-default default” plan succeeds, it might actually make the situation WORSE by rendering CDS insurance worthless even as banks take huge de facto losses on their devalued and NO LONGER HEDGED (as CDS are moot) sovereign debt liabilities.
And never mind, of course, the monkey wrench of Greece itself (and the high possibility of the Greek populace refusing harsher austerity measures under any conditions)…
Or the high likelihood this whole thing could be repeated all over again with Portugal, or Ireland, or even Spain…
Or the odds of getting private creditors to go “voluntary” in the first place, a task akin to herding wet cats…
Yep, gonna be a fun week next week.