Today, 20th April Athens had to sell €1.5 billion in debt. Experts said it was another test of Greece’s ability to continue borrowing. So the fact that they sold €1.9B has been reported as a triumph. But it wasn’t. Here’s why.
This debt does not give Greece more money. This debt sale only replaces previous short term debt that is maturing. The old debt had to be repaid and new debt sold just to replace it. The new debt is itself short term maturing in 3 months. SO late June Greece has to raise another 1.9B to replace this lot.
ANd this leads to the other reason it is NOT geed news. The rate Greece had to offer to pay its creditors on this new debt is DOUBLE what it paid before. The rate it was paying when it sold the debt on 19th Jan. was 1.67%. Today for the same money they are having to pay 3.67%.
So the real headline is that today Greece was forced to double its payments on 1.9B of its debt.
Of course optimists will point out that there was no shortage of buyers. The bid to cover ratio was 4.6 which is good. But what does that really say? Easy, just put yourself in the bond buyers shoes. The buyers said to Greece, we’ll buy your debt, ie lend you our money – but only for three months and only at double what we charged you only three months ago.
The same bond buyers also made Greece pay double the previous rate on its one year debt and TRIPLE on its 6 months. What this says to me, is that the bond buyers think Greece will pay its bill for the the next three months but after that they are not sure. The rate demanded on Greece’s ten year debt is now an all time record high of 7.82% which is 4.83% MORE than Germany pays.
The next month Greece has to sell about @12B mostly to replace maturing debt and to deal with a new funding gap. All the while the cost of this debt is itself growing adding to Greece’s over all debt burden.
Hi Golem
Who are the bond buyers? Are they speculators working for banks and governments? Is it a transparent/public process?How did Greece pay out on bonds that matured in April?How do CDS work in favour of hedge fund speculators hoping for Greece to default on these bond/loans.As you see I need an education.
Pilibi
First, I am not an expert. But I can answer some of your questions.
Bonds are bought by nations who need to repatriate foreign earnings. This is why China and Japan have so much US debt. They are also bought by investment companies, pension funds, banks and even wealthy investors as part of their mix of investments. When you hear of a 'flight to safety', or a 'move to low risk' that means bonds. They are generally a lower return but safer investment.
Bonds are generally sold by governments via intermediaries who are a small group of the largest banks who are called Primary Traders'. They guarantee to buy up bonds and sell them on.
It is NOT a transparent process at all. For example the FED lists the types of buyers for its debt but does not reveal names. They use categories such as direct and indirect bidders. A year or so ago the fED changes who was classified as what resulting in it being impossible to tell if central banks were buying. Why change, why then and why the specific change they made?
How did Greece pay out? I cannot possibly say for sure without inside knowledge, which I don't have. But the likely method is much akin to paying off one credit card by charging it off onto another. Greece has credit lines and even some cash. Or, most likely, they used the cash from today's sale to pay off the maturing debt. That is why refinancing short term debt is nasty. The more of your debt you are forced to issue in short term the more unstable you become.
The best, simplest and most generally accurate way to think of CDS is to think of them as insurance. I buy a bond. I want to insure my investment against the chance of it defaulting and me losing all my money. The insurance is called a CDS. I go to a company who sell CDS. AIG was an example. But all the banks sell them. Hell, I could sell them. Often buys of cds are also sellers. Sounds doolal and it is.
The agreement is the buyer (me) pays a premium to the seller. In return the seller agrees that he will buy the bond from me for the full or par value of the bond if it ever defaults.
Sounds reasonable but the CDS market is utterly unregulated. And so it turned out almost no one selling CDS had ever had the cash to make good on their 'insurance' and pay up. Think AIG again. By the way it is still the situation today. Which in turn is why regulation of the market will not happen. You regulate it and you force everyone to admit they are insolvent.
Now the best bit. It is one thing for me to insure my investment right? I have insurance on my house. But with CDS you can take out this insurance on anything you like. You don't have to own it. SO you could take out cds insurance on my house. Meaning you would get paid the full value of my house should it burn down. So now my house is insured by you as well as me. Only difference is I still don't want my house to burn down. You do because then you get paid.
The cds speculation on Greek debt is exactly like this. Bet's placed on their house burning down. The market knows what bets are being taken because the riskier the insurers think it is to 'insure' the CDS bets against Greece the more they charge. They more expensive it is to insure Greek debt. The more expensive it is the more the bond buyers will have to charge to buy the debt in the first place.
Why? because they have to buy that insurance and still need a profit from the debt they bought. Hence they need to factor in the cost of the CDS into what they charge to buy the debt.
The more the buyers charge Greece for buying its debt the riskier it all seems and the more the speculators place their bets and around and around it goes.
This is, I hope you understand, an outsiders view and a simplified one. But in its essentials it is correct.
So THAT'S what they are! Excellent and informative explanation, thanks for that! Maybe you ought to turn this into an entry for those people who read your blog but aren't anal enough to read the comments 🙂
Hi Golem,
thank you for such a comprehensive reply.So just to be clear and slightly pedantic, it is the bond buyer who will also buy a CDS to insure himself/herself against person/government failure to repay the loan/bond/debt.But the crucial idea is that anyone can take out a CDS on the same deal even if they have not bought the bond in question.So it like taking bets on both sides of the same transaction with no money to cover them if the bond seller defaults.I read somewhere, maybe you, that a Credit Default Swap could never have been called Credit Default Insurance, because insurance products are regulated.You might be interested in this letter that appeared in the Irish Times (voice of the establishment in Ireland) today
http://www.irishtimes.com/letters/index.html#1224268869561
Pilibi,
Yes for the bond buyer its betting both ways – hedging their bets. Hence the hedging and hedge funds etc. And yes others aren't hedging they are making a one way bet on something they don't own. They could of course hedge that bet too as could the insurer who sells the CDS. From whence all the talk of not knowing where the liabilites and losses will finally wind up. Everybody hedges with everybody and often a trail of hedges crosses back in some form to the bank that started the chain.
For example Greek banks bought much of their government's debt. Thus a Sovereign default will kill them. Those banks did cover much of that debt by buying cds on it. Sadly they bought much of it from each other. Fanatastic. Each bank trying to eek out a little extra cash flow from offering insurance they will never be able to pay.
And yes, not called insurance for precisely that reason. Insurance is regulated the banks et al are spending many tens of millions lobbying/bribing congressmen to make sure regulation does not pass.
Thank for the link to the letter. Disingenuous is the best I can call it.
"Goldman Sachs never represented to ACA that Paulson was to be a long investor".
NOT the point. The point is that GS did not tell ACA that Paulson and they both had chosen those mortgages specifically because they thought they would fail. Paulson was going to short them. That they kept secret.
Another wrinkle which lets you know what a small world finance is. The head of ACA at the time, Alan S. Rosenman, was and is married to a senoir Goldman Exec.!