The Stele of the Vulture

I predict a Greek GGB default in July. Greece will make payments to the IMF, and EFSF payments are not due for a good period of time. It is GGBs that will bear the brunt. There will be a bail-in imposed on bank deposits. The Syriza government will collapse. A less utterly incompetent government will take its place, which will agree to a new MoU with the EU. Grexit averted.

A GGB default would cause impairments at the ECB and with other holders. Considering that these bonds are already priced in the 50s, the implied loss rate is about 70%. A GGB default would impact the global financial system through Greek banks. Greek banks have very little sub debt. Secured debt is considered protected. So depositors will be the first to take a haircut: first unguaranteed deposits, then guaranteed deposits. Unguaranteed depositors know this, and will or have already pulled their money out of the banking system. Deposit guarantees are essentially worthless when backed by a bankrupt state anyway and only a sucker wouldn’t know this.

Here's the detail.

For a few fleeting months, there was the hopeful euphoria that Syriza would to step in where past governments failed and negotiate the bargain needed to restructure Greek debt with no pain felt by these debtors. This euphoria is gone. The debtors can now see past the smoke-screen of a “return to the drachma” (doesn’t solve anything, by the way), threats of Grexit (generating contempt and hostility through the EU), claims for war reparations, and going hat-in-hand to scum like Vladimir Putin. Syriza has shown themselves to be a bunch of clowns totally over their head and that have absolutely no clue.

The euphoria is gone like a vapor, but the reality that no one is walking away from this unhurt is only now setting in. Greeks will hurt most by far in any possible case. If Syriza honors wages and pensions as opposed to creditors, the banking system will fall apart and depositors will be bailed-in. Wages and pensions will be dishonored by an attack from the rear. The government will be forced to cannibalize the economy, default or not. That is to say: Parts of the Greek economy will feed on other, less politically connected parts to survive.

Most private creditors have shed their exposure to Greek debt, except for Greek banks. Public creditors have been so infuriated and stand so exposed that there is little for them to do but stand over the ruin and raise their standard. They will raise the stele of the vulture: It threatens any other EU country that would think of going the same route as Greece with being picked clean under the blazing sun.

The Straight Dope

Greece has managed to dig up cash when needed to make key payments and avert default because Greek pension funds have been willing to lend it the government on a “voluntary” basis and government agency transfers have supplemented this. On April 27th the country paid €1.7 billion in wages and pensions. It survived €1.4 billion in t-bills maturing on May 8th. Tomorrow (May 12th) Greece has €770 mln payment due to the IMF. It is possible that there will be sufficient pension reserve and cash on hand to make the latter two payments coming up. But in July, it has a gigantic payment due to the ECB on PSI-GGBs. Without a deal involving additional financing, Greece will default on this one. There is not enough cash in the country to cover this one.

The Greek budget is now running cash flow negative. The government expected tax arrears coming in to the tune of €200 million. This is now shown to be a joke. Greece is constrained to only roll €15 billion in t-bills, it cannot issue additional debt on the market, per MoU with the Trioka. The pensions have been raided and are now as bankrupt as the government. Government agency transfers are exhausted. There is an estimated €5 billion in cash and equivalents held by munis and provinces, but attempts to impose capital controls and collect this cash is unlikely and will be challenged in court, as Greek law explicitly protects munis from these kinds of operations.

Non-EU options? There has been talk of Russia providing funds in exchange for a pipeline deal with Gazprom, but Gazprom has denied it, and Russia isn’t in a position to be providing money to other countries given its own economic situation. Doing so would also only further aggravate relations with the EU. For China to source funding for them would require even more draconian efforts than the Troika. Greece is backed into a corner, relying on the very creditors they have insulted and frustrated by its own ineptness.

Greece and Syriza remains obstinately unrealistic about the situation. Greece refused to reform its pension system per EU request, and there is next to no possibility of this passing parliament even if it did come to vote. What this means is that Syriza is willing to raid pensions of all capital but is not willing to be honest about it and put these plans on a sustainable path. This always ends with current employees being paid however meagerly and retirees losing and future retirees losing it all. There is some potential capital-raising possible by selling off state assets, but privatizations are a non-starter as well given that the socialist platform actually calls for further nationalization as a remedy.

The IMF at this point wants to reduce its Greek exposure. The IMF is in theory super-senior to all other creditors in the same way that bridge financing is senior to other corporate debt. Greece has brought this seniority into question. Most IMF member countries are in fact poorer than Greece and there is a growing consensus that has nothing but contempt for them. The IMF will not release further payment to Greece. There is no grace period in consideration in this situation.

The ECB is the biggest bag-holder in this mess holding about €110 billion in bank financing and emergency refinancing liabilities. When Greece entered its technical non-default and re-profiled its debt under PSI, the ECB bought up the debt from banks. This operation cleaned up bank exposures to Greek GGBs, but it also places potential for massive losses with the ECB. Theoretically the losses rest with the Greek Central Bank, but they are far too large for the Greek central bank to absorb. So ultimately, if Greece defaults, and stays in the Eurozone then losses would be shared among EU members. If Greece exited the Eurozone, the Greek central bank would default on its liabilities, leaving the ECB on the hook for that €110 billion. One look at the largest European bank CDS spreads makes it is clear that they have reduced their exposure to Greece to levels that the market considers inconsequential. In terms bank balance sheets, a Greek default at this point does not appear to have the same impact as it did in the past.

Greek Banks

Greek banks, however, are set for destruction. Syriza is a populist tool whose incompetence is offset by tapping into public rage. Banks are the perfect object of this rage: they are at the mercy of laws that protect homeowners from foreclosure. In draft is a law that will protect homes with values as high as €300K. So they dare not resolve their massive NPL problems. The purported “safe” Greek sovereign debt they hold in t-bills and PSI exchanged bonds are worthless in a default. The asset side of their collective businesses is essentially non-performing and collateral cannot be exercised on it or it is worthless. On the liability side, banks have had little capital market access for years and they depend on retail deposits and ECB emergency funding just to survive.

Deposits are notoriously flighty subject to rumors of sovereign default/capital controls/return to the drachma. Currently they have a €2 billion buffer in emergency lending from the ECB, which will not last long given a bank run. So on the liability side, Greek banks are crucially propped up by ECB emergency lending. Should Greece default, ECB lending to Greek banks will stop. Greek banks will be nationalized.

I do not think that Greece will default on wages and pensions immediately. This will come later. I also do not think that Greece will default on IMF payments. This would put them in uncharted territory and in the end reduce them to a pariah state. EFSF payments are not owed for a long time, so it doesn’t make sense to hit this until it is necessary. What is left is a default on GGBs and Greek t-bills. This paper is post-2012 PSI and under English law.

A GGB default would cause impairments at the ECB and with other holders. Considering that these bonds are already priced in the 50s, the implied loss rate is about 70%. A GGB default would impact the global financial system through Greek banks. Greek banks have very little sub debt. Secured debt is considered protected. So depositors will be the first to take a haircut: first unguaranteed deposits, then guaranteed deposits. Unguaranteed depositors know this, and will or have already pulled their money out of the banking system. Deposit guarantees are essentially worthless when backed by a bankrupt state anyway and only a sucker wouldn’t know this.

If the deposit bail-in makes bank secured creditors whole, then the effects of a Greek default will be contained. If deposit capital is insufficient to do this, then all bets are off. These kinds of “regime change" cause risk premium to rise across the board.


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