Risk free bonds


How is that even after the proposed 50% haircut on Greek bonds, the Greek debt to GDP ratio is forecast to fall only to 120% by 2020? The answer is that the haircut only applies to privately held debts, not to official debt. Punish those nasty speculators, not government or agency creditors. There are a number of problems with not treating all debt as equal. Firstly, the required haircut for private holders must obviously be larger in order to give Greece the same level of debt relief. Which would make any smart private holder worry about lending to sovereigns in the future – hence rising interest rates for Italy and other debt laden European economies. A related problem is that in their desperation to have any scheme be “voluntary” so that CDS (insurance) payouts are not triggered, European authorities are likely to deter holders of insurance on European debt. Without access to insurance, the cost of debt will again rise. I wrote a piece a while ago about Ecuador’s default, and my puzzlement as to why the IMF insisted on being paid while at the same time not protecting private bondholders. I am still puzzled. Why does it make any sense to punish the private sector, and then expect fresh loans to “risk free sovereigns” to be forthcoming?

One Response to "Risk free bonds"
  1. 3rd point (really an extension of your first point) is that they have now created two classes of government debt – the class owned by private investors is now subordinated to the debt owned by the ECB / IMF. Therefore private investors should want a premium to buy this type of debt and this creates an unwanted addition level of leverage that means the more debt that the ECB / IMF pay, the worse it is for private investors – the opposite to what they are intending.

    eg if Italy owes 1,000b but I only think they can afford to pay 800b then everyone will need to take a 20% haircut and I price that into the amount that I pay for the bonds. If however the ECB/IMF step in to “help” and buy 20% of the outstanding debt, this means that the ECB/IMF will get 200m leaving the rest of the debt holders now with only 600m of the remaining 800m face value – i.e. now private holders have to take a 25% haircut and so will bid the price of debt up higher… 

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