On 2012-02-19, at 10:43 PM, Chuck Grimes wrote:
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>> Apparently, ECB has unilaterally changed the definition of Greek bonds.
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>> I don't quite get this stuff. Comment?
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>> http://www.zerohedge.com/news/ecb-has-opened-pandora%E2%80%99s-box
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>> Joanna
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> Joseph Stiglitz wrote a piece on AJE that may help, but certainly confused me:
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> ``Nothing illustrates better the political crosscurrents, special interests and shortsighted economics now at play in Europe than the debate over the restructuring of Greece's sovereign debt. Germany insists on a deep restructuring - at least a 50 per cent "haircut" for bondholders - whereas the European Central Bank (ECB) insists that any debt restructuring must be voluntary.''
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> http://www.aljazeera.com/indepth/opinion/2012/02/20122101182411133.html
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> So the piece you posted must be a complaint that bondholders were handed the haircut with no choice, hence the re-write of the terms of the contract. I am guessing. The contract we made was worth ten dollars. Now its worth five. Or something like that.
Stiglitz's piece does not refer to the ECB's recent bond swap with the Greek government. The Zero Hedge article does, and like many others, slams the swap as a controversial and unorthodox move which protects the ECB against an eventual default by the Greeks, widely seen as inevitable, at the expense of the banks, hedge funds, and other private creditors.
Essentially, the ECB has compelled the Greek government to replace its existing debt with new debt, except with the same term structure and nominal value. In other words, it is not technically a swap at all, which occurs when a debtor defaults on its existing commitment and issues new bonds with typically a longer term, lower interest rate, and hence nominal value. The difference between the old bond and the new bond is, of course, colloquially described as an "haircut" forced on the creditors. If the Greeks would have defaulted on some of its outstanding sovereign debt maturing next month, the ECB would have been paid the full purchase price of its ostensibly "new" debt.
The ECB insisted on the swap as a condition of its latest loan, which has postponed a Greek default for now. But the Greek parliament is also expected to pass a motion this week making it easier to default on its other debt by retroactively inserting so-called "collective action clauses" in its bonds. This means that recalcitrant bondholders will not be able to hold out in a later restructuring if a two-third majority agree to accept an imposed haircut. This is standard practice in US and UK insolvency proceedings and is designed to facilitate an orderly resolution, but this provision is lacking in sovereign debt issued in Greece, and the decision of the government to make this feature retroactive has caused further storm in bond market.
By swapping its bonds, the ECB has, in effect, immunized itself from any subsequent defaults, and will not have to mark down its considerable holdings on its books. This is more of a political than an economic issue for the central bank, which can simply print money to restore its balance sheet. But the ECB has been slammed by the Bundesbank and other monetary conservatives for buying Greek bonds and those of the other highly indebted European states, and does not want to record any losses if even on paper. The ECB deal with Greece also puts pressure on private investors to agree to a voluntary default — euphemistically termed "private sector involvement (PSI)" — to avoid triggering credit default swaps and putting further pressure on the tottering European financial sector.
The swap is likely to result in extensive litigation by some private investors who believe the manoeuvre is illegal because it violates the fundamental principles of debt restructuring, and they have issued dire warnings of European sovereign debt markets freezing up entirely if private holdings are treated as subordinate to those of the ECB.
Some helpful explanations of this complex issue at these links:
http://openeuropeblog.blogspot.com/2012/02/decoding-ecb-bond-swap.html
http://blogs.reuters.com/felix-salmon/2012/02/17/the-greece-game-turns-chaotic/