EurAnalysis

The headlines are about Greece, but the real story is not Greece but who is next.

European leaders were right to be worried only a short while ago about contagion effects of a Greek default to the entire Euro system, which of course they now say doesn’t exist. This week we look at Europe, and sort through the ever more fascinating implications of the news in today’s headlines.

The citizens of California have chosen to let a series of cities enter bankruptcy, severely cutting police and fire, health, and other services. Europe has had about all the pleasure of bailing out Greece that it can handle, and is clearly ready to say, “Enough!” It is all very sad, but that is the consequence of too much debt and leverage. And every nation is subject to that consequence if it does not keep its own fiscal and economic house in order. Every nation.

The ISDA Steps Up

The ISDA (the International Swaps and Derivatives Association) declared today that

Greece is in official default. This is a derivatives-industry committee of 15 members, representing the largest banks and derivative buyers – all the usual suspects. I started to write last week about their hesitancy, but it was very technical and I thought it likely they would issue the ruling they did this week. There are a few things we should note about this decision.

First, there is a widespread misunderstanding that the ISDA is the final answer to whether a nation is in default. The correct answer is, it depends. Credit default swaps are contracts between two private parties . The actual original contract is the governing document.

While most contracts named the ISDA as the final arbiter of default, there are many that did not. Some experts told their clients there was a problem with choosing a self-interested industry group to be
the final judge, and were very specific in their contracts as to what constituted a default. (Thanks to Janet Tavakoli, who spent an hour late one night patiently explaining the arcana and minutiae
of credit default swaps. She literally wrote the book – and not just one but three of them – on swaps.)

Secondly, the number that keeps showing up in the press is that there are only $3 billion of credit default swaps on Greek debt. That is only half true. The reality is that there is a NET $3.2 billion of CDS on Greek debt. The total or GROSS amount of swaps written is estimated to be about $60-70 billion (Dan Greenhaus, Chief Global Strategist, BTIG). This is in the 4,323 contracts that are known about.

Of the net exposure, the loss is likely to be less than the $3.2 billion, unless Greek debt goes to absolute zero. But that does not tell the whole story. For instance, just one Austrian stateowned
“bad bank,” KA Finanz, faces a hit of up to 1 billion euros ($1.31 billion) for the hole Greece's debt restructuring punches in its balance sheet. That loss, which will be borne by Austrian taxpayers, is someone else’s gain. The net number means nothing to them – they lose it all, over a third of the expected total loss.
Every bank and hedge fund, insurance company, and pension fund has its own situation.

Care to wager that the larger banks won’t win on this trade? My bet is that there will be $30 billion in losses, out of which maybe someone will make $27 billion in gains.

Will the counterparty that holds your offsetting CDS be able to pay? Will all taxpayers be so accommodating as Austria’s? Does anyone think that taxpayers will bail out a hedge fund that cannot pay its debt, if it sold protection and has to default?

“As Commerzbank CEO Martin Blessing recently put it, this deal was as ‘voluntary as a confession during the Spanish Inquisition.’

“Truth be told, Greece can rightly argue it had no choice but to use coercion. Any less than 95% participation and the European Union would not have approved the latest EUR130 billion bailout, leaving the country unable to pay its bills and thrust into a more damaging,
disorderly default.”

And By the Way, Close Your Borders...

See Article On Link...

"‘Portugal's debt is unsustainable. That is the only possible conclusion,’ said David Bencek, the co-author, warning that no country can achieve a primary budget surplus above 5pc for long.

‘We won't know what the trigger will be, but once there is a decision on Greece people are going to start looking closely and realize that Portugal is the same position as Greece was a year ago.’"

“Sadly, that article is exactly right. Portugal is marching down the exact same road that Greece went down. The yield on 5-year Portuguese bonds is now up to an all-time record 19.8 percent. A year ago, the yield on those bonds was only about 6 percent. This is the same thing that happened to Greece. A year ago, the yield on 5-year Greek bonds was about 12 percent.

Now the yield on those bonds is more than 50 percent.”

The world is facing a debt crisis unlike anything ever seen before, and Europe is right at the center of it.