Monday, January 30, 2012

Greek pre-packaged sovereign debt cram-down likely to break all precedents in rule of law and fair bankruptcy distribution

Greek PSI+ negotiations exhibit EU-engineered “survivor bias” making a mockery of core bankruptcy law principles. Capital losses are put on private sector bond holders whilst public bond holders are excluded from mark-downs of their debt. Only those private creditors with interests against outright default (large banks) are represented in the negotiation process. Troika bailout funding to Greece is nothing but a pre-petition Debtor in Possession (DIP) loan, with a first lien and collateral protection. The ECB is essentially conducting a quiet Greek debt-for-equity exchange in the purchase of Greek debt.

European Union (E.U.) policy planners have always shunned transparent market-driven pricing mechanisms in their currency union, showing contempt for rating agencies and market players. They consistently claim the right to be able to set asset prices arbitrarily as it suits them. The Greek PSI+ is a stealthy pre-packed bankruptcy restructuring, without being represented as such.

The main barrier to concluding this pre-packed Greek bankruptcy is the necessity of some majority of bondholders to ratify the final PSI+ debt exchange offer. As the bulk of Greek bonds do not have a collective action clause (CAC) (a framework which says what percentage of favorable votes is needed to enforce a decision), ratification would require 100% of investors to accept the new terms in order to avoid triggering a default, an almost impossible hurdle. Implicitly, the Greek negotiation process requires retroactive imposition of CAC. On one hand, retroactive CAC would facilitate the "exchange offer", however it would create great distrust of any bonds issued under domestic law in other European countries.

This would not, however, be the end of the ratification problem. Greece also has issued a modest amount in bonds, somewhere over €25 billion, under U.K.-law. While Greece could retroactively force local-law bondholders to do pretty much anything under local Greek law, it has no chance of doing this with this U.K. class of bond holders. It is precisely these bonds that allow some form of plurality to be enforced and which override the government's attempt to enforce a unilateral decision of creditor stripping.

Distressed asset investors seek these kinds of opportunities, which historically have had very high recovery rates in subsequent litigation. It is highly likely that some hedge fund cartels have already built up a blocking stake in the U.K.-bonds. It’s no surprise that E.U. policy planners have deliberately shut these creditors out of the PSI+ negotiations.

The E.U. continues to believe that it can shortchange market pricing mechanisms and manipulate its way over financial markets to preserve the currency union and avoid the day of reckoning. Yet demand for risk comes from a sense of stability, of fair and efficient markets, and equitability. A coercive cram down on any one, or all, Greek bondholder classes would make it crystal clear that E.U. authorities will put private sector investors into junior position arbitrarily any time they see fit, adding to the perils of holding E.U. sovereign paper.

A hard sovereign default would make “mark to market” unavoidable, thus exposing the underlying fragility of the banking system and triggering the collapse of the E.U. Ponzi debt structures used to keep weaker members on life support. E.U. policy makers have been calling for a €1.5 trillion rescue umbrella, but are unable to come with any real funding. Predictably, the ECB is rapidly expanding its balance sheet; there is no way to fund their Ponzi debt pyramid other than with massive back-door money printing.

This risks a broad sell-off of indenture bonds of the other PIIGS nations that might eventually lead to the collapse of demand for European paper and severe loss of confidence in the ECB.

Even Germany has a perilously undercapitalized banking system. Already they are discussing a delay in implementing the Basel 3 accords. State recapitalization of the German banking sector would likely lead to a sovereign credit downgrade.

Is it any wonder that institutional investors seem reluctant to take the bait in the face of this fudging, financial manipulation and fraudulent accounting?

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