Zero Hedge
January 22, 2012
Yesterday, Reuters' blogger Felix Salmon in a well-written if somewhat verbose essay, makes the argument that "Greece has the upper hand" in its ongoing negotiations with the ad hoc and official group of creditors. It would be a great analysis if it wasn't for one minor detail. It is wrong. And while that in itself is hardly newsworthy, the fact that, as usual, its conclusion is built upon others' primary research and analysis, including that of the Wall Street Journal, merely reinforces the fact that there is little understanding in the mainstream media of what is actually going on behind the scenes in the Greek negotiations, and thus a comprehension of how prepack (for now) bankruptcy processes operate. Furthermore, since the Greek "case study" will have dramatic implications for not only other instances of sovereign default, many of which are already lining up especially in Europe, but for the sovereign bond market in general, this may be a good time to explain why not only does Greece not have the upper hand, but why an adverse outcome from the 11th hour discussions between the IIF, the ad hoc creditors, Greece, and the Troika, would have monumental consequences for the entire bond market in general.
But before we proceed with the analysis, we should point out one minor nuance: Salmon, and thus the WSJ's Fidler, are correct that Greece has all the leverage in the world, in the same way that a suicidal person has all the leverage to take their own life as they stand on the ledge of a skyscraper. Because from a strategic standpoint, the reality is that over the past 2 years, the entire financial establishment has done everything in its power to mask the fact that Europe is currently undergoing a stealthy restructuring, without it actually being represented as a restructuring. The reason for this is that while an ex-event of default status quo allows the world's financial establishment to continue marking sovereign debt, even highly impaired one (remember: central planners are always right, markets - always wrong in pricing risk, or so the central planners say), at whatever prices it desires (recall that one of the very first things to happen in the post-Lehman collapse was the elimination of the Mark-to-Market statute, thus affording banks a plethora of gimmicks to mark 'assets' on their books at any valuation that excel spews out based simply on input assumptions, which in some cases are openly fraudulent), a case of sovereign default will very likely make mark to market unavoidable, thus exposing the proverbial nudity of the emperor. It also has implications for the ECB, for CDS triggers, and other consequences, but those are of secondary importance for the time being. Most importantly, the Nash Equilibrium at least until now, had afforded creditors, who in many cases have known very well that they have 'weak protections' on their sovereign holdings (more on this in a second), the myth that they are not subject to subordination, or seniority claims on their holdings, and thus the sovereign market was uniform, or pari passu. The outcome of the Greek negotiations, should Greece indeed use the "nuclear option" and force a coercive cramdown on any one, or all, bondholder classes, would do away with this myth in the blink of an eye, and instantaneously create a split between what will hence be perceived as senior and subordinated sovereign bonds. These are all considerations that the ECB, that European banks, and most importantly European sovereigns (and Greece) are all too aware of, and since the need to fund future deficits will only rise, any impairment of the sovereign funding apparatus is not only suicide for Greece, but for Europe, and eventually for the rest of the developed world.
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