Greek Default: Good News?


Anyone following the news this morning would have heard about the agreement of bond holders to accept a write down on their holdings of Greek Sovereign Debt of 172 billion Euros. In financial jargon, the bond holders have taken a haircut, which means they have accepted the fact they will not receive back all their capital at maturity of the bond.

The figures announced this morning show that the potential write down of debt is up to 74%. What this means is that if you had lent (or invested) 100 pounds, you will receive back 24 pounds. Good deal? Doesn’t sound like it to me!

I can remember a quote given once where it was said when you owe the bank 1,000 it’s your problem, when you owe them 1million it’s the bank’s problem. Owning Greek Government debt has become the bond holders’ problem, not the Greek Government’s problem.

By “bondholders”, who do we mean? It appears that the main holders of Greek Sovereign Debt are the Greek banks and the major banks in France and Germany. They may be the main losers from this, but there are probably a lot of financial institutions, pension funds and unit trusts which have invested a portion of their capital in these bonds, the effect of which is to see that part of their holding reduced by up to 74%.

That by any standards is a huge loss and prompted me decide to review the historic yields on Greek Sovereign Debt over the last few years to try to put the story together in the context of risk to the investors.

In 2008 when the credit crunch occurred, Sovereign Debt was considered a risk-free investment by all the credit ratings agencies. Being risk-free meant that financial institutions could invest in these assets and hold no reserves against potential loss on these investments. At the time Greek 10-Year bonds were trading on a yield of just under 5%.

By May 2010 the international financial community were realising that the Greek Government had no control over their finances and had been borrowing profligately off the back of being part of the Euro zone and the credit worthiness of Germany. This, you might think, looks like something akin to an errant teenage drug addict “borrowing” their parent’s credit card…

The first aid package was announced which lent the Greek Government 110 billion Euros. The yields on Greek Sovereign debt rose to 12.5%, which for sovereign debt means the market believes it would default.

The political ramifications around Europe of a possible Greek default and the potential exit of Greece from the Euro led political leaders to set up the European Stability Mechanism which would go into action by mid 2013. It was probably already accepted within political circles that Greece would default, but the ESM may stop some of the other countries in Europe going the same way. The politicians were looking for a way of continuing the grand European experiment rather than solving the economic woes of Europe.

By July 2011 a second bailout package was announced for a further 109 billion Euros; this was purely to buy time to ensure that when Greece did finally default, it could be done in a more orderly manner. The 10-year gilt rate at this time was over 17%.

We now know that Greek Debt has been restructured, with potential losses of up to 74% for bond holders. That, to the average person would be considered a default. In the world of finance though we have to wait for the International Swaps & Derivative Association (ISDA) to meet to enable them to determine whether this is a default or not!

You may wonder why this is important. The reason is that a lot of financial institutions purchase Credit Default Swaps (CDS), which is like an insurance policy on whether Greece would default on its debt. If the ISDA determine this is a technical default it will trigger 3.2Billion Euro’s of credit default swap payments (claims, in insurance parlance).

Personally that would not help fill the chasm created by the loss of value on these assets. This insurance payment only compensates bond holders to the value of less than 2% of the capital they have lost.

Following the story of Greece over the last few months has led me to think about risk in a different way – and the way the market tries to price risk. Prior to default, Greek 10 Year bonds were yielding 23.1%. When Sovereign Debt is this high it would suggest that default is most likely. You could argue: Does a 23% income compensate for a 74% capital loss? The answer is obviously no; and we can make this statement with the benefit of hindsight.

The deeper question I believe is what does this say about professional money managers; why were they happy to accept this risk? Is it because they weren’t actually risking their own money, but investors’ and shareholders’ money? It also suggests that the market also does not calculate risk very effectively and that appears to be the case especially as the same thing happened with sub-prime lending back in 2008.

I believe people have to start thinking about risk in a more fundamental way and not accept what financial advisers and professionals tell them, as evidence suggests they are not very good at it themselves.

What this teaches the enlightened investor is not to allow somebody else to take control over your investments, but to manage them yourself and to decide which the most appropriate trade-off to accept is.

There are many investments available which will give the investors a good risk/return trade off. One investment I am looking at currently enables you to only put at risk 20% of your capital at any one time but with the opportunity of delivering an average of 20 to 30% annual returns; sometimes more.

This, to many professional money managers, would be considered high risk; but then, these are the same money managers that decided to invest in Greek Sovereign Debt…

I feel we are now in a period where the previous norms and investment protocols no longer apply. We have to start approaching investing in a new way and not accept the principles and advice that the so-called experts have been giving us over the years.

Developing your own investing expertise and personal financial plan is, I believe, the better way to go. In my opinion investing has just taken a paradigm shift. It would be a significant advantage for you to approach future investing with this in mind.

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