Greek workers have taken to the streets again this week to fight against further austerity measures in their country as the nation's political leadership tries to strike a deal with private creditors, bond holders and the IMF to restructure its debt in hopes that it can avoid a full, and disorderly, default on its sovereign debt. Beneath it all, however, lurk the same lingering financial instruments hatched by the same familiar Wall Street institutions that led to the financial collapse in 2008.
The Indepenent in London reports this morning:
A group of hedge funds is threatening to block a last-ditch attempt to save Greece from defaulting on its huge debt pile, unless they are guaranteed a significant payout.
There will be a final attempt today – when a group representing Greece's private sector bondholders meets senior ministers in Athens – to negotiate a writedown of the value of the country's debt ahead of a crucial bond repayment deadline next month.
Sources familiar with the talks, which collapsed at the end of last week, have said that a number of hedge funds are holding up the restructuring deal to ensure that they make a fat profit, after snapping up Greek bonds at distressed prices.
Les Leopold at Alternet, summarizes the situation succinctly:
Greece does not have enough money to pay off the loans that are coming due in the next year. So the EU and the International Monetary Fund have assembled a bailout package to help Greece make those payments. In exchange, the Greek people are being asked to suffer through enormous cuts in government spending – which means cuts in jobs, incomes, healthcare, pensions and public education. Everyday citizens are making enormous sacrifices.
But the European Union also insists that the bond holders of Greek debt take a hit. After all, under the supposed rules of capitalism, if you make a bad loan, you suffer the losses. So the EU wants to recall the old bonds and replace them with new ones at lower interest rates more suited to Greece’s financial condition. Imagine that! Financial elites are being asked to sacrifice a bit to pay for the problems they helped to create.
Well guess what? The elites don’t like it. You see, hedge funds have been buying up Greek bonds at steep discounts. They want to milk the deal for as much as possible. So they are refusing to accept what the EU is offering. The hedge funds want to capture as much of the bailout money as possible. They could care less if the Greek people suffer. (Think Bain.)
But, even though the bold holders don't "like it" -- they're only so much they can hold out for. Indeed, many bond holders, are not so much worried about default as they'll get paid on their bargain basement investment either way. That's because ("it's believed") many of them have purchased insurance from large financial firms in the form of 'credit cefault swaps' (CDS) which insure their investments against a Greek default. As the Independent explains:
If Athens fails to pay its maturing debts in March, that would trigger large CDS payouts to these funds from the large financial firms that sold them the insurance. [...]
[And] a hedge fund source denied that the behaviour of small investment funds was frustrating a voluntary deal – and possibly even forcing a default – arguing that the voluntary basis of the restructuring deal being pushed by the IIF and European leaders was "crony banking". "Who will lose out if the insurance is paid out?" he said.
"The two biggest issuers are Goldman Sachs and AIG. They are effectively being given a bailout by not allowing Greek debt to default. Seven Goldman Sachs ex-employees are in European Union governments. This is crony banking at its worst."
And here's where the story gets to "the rotten core of modern finance," as Leopold describes it.
These hedge funds think they have covered their bets by taking out financial insurance on their bonds, which would pay them the full value of the bonds (not just the discounted price) if Greece defaults. (These insurance policies are called credit default swaps, and are issued usually by big banks that profit on the insurance premiums.)
So the hedge funds that are playing hardball think they have their bets covered. If Greece doesn’t give them a better deal on their bonds, the hedge funds will welcome a default in order to collect fully on their financial insurance policies.
There’s only one little problem: The entire financial system might collapse, including our own, if Greece defaults. That’s because no one is sure if all the financial insurance can actually be paid off. It could be like AIG all over again, when that giant insurance company couldn’t pay off its financial insurance policies. If one big bank fails to deliver it could set off a chain reaction of financial defaults around the globe.