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Greece Nearing Deal on Sovereign Debt Haircut

In Greece, creditors and the government continued their work on a debt deal that would give a haircut to debt holders and set a new interest rate going forward, reducing Greece’s debt level. After hedge funds appeared to be playing a game of chicken by holding out on a deal, cooler heads may have prevailed.

Greece was closing in on an initial deal with private bond holders on Friday that would prevent it from tumbling into a chaotic default but lose investors up to 70 percent of the loans they have given to Athens.

The agreement, to be followed up by technical talks over the weekend, could come later in the day, sources close to the negotiations said.

Private bondholders would most likely incur a real loss of 65 to 70 percent, with the new bonds having a 30-year maturity and offering a progressive coupon, or interest rate, averaging out at 4 percent, a banking official close to the talks told Reuters.

That’s even more than the 50% haircut proposed by the EU. European officials have tied a deal on the debt to the release of another tranche of bailout funds for Greece.

Even in the event that this deal happens, Greece’s debt load would remain 120% of GDP, down from a less manageable 160%. And the real problem for the country is not necessarily the debt, but the crushing burden of austerity, which has impoverished practically the whole country (the same thing it’s doing to Ireland, incidentally). Without economic growth, this reduction in the debt load will simply be followed by another increase. Austerity has not only led to national poverty in Greece, but also more borrowing as the tax base collapses.

The hedge funds may still hold out against this deal, at which point the Greek government is prepared to force the haircut through by changing Greek law. That’s when the hedgies may sue in human rights court, of all places. But we’re not quite there yet. If Greece can get a 75% participation rate from the bond holders, they could force the terms of the agreement on all bondholders through collective action rules written into the bonds.

The other issue is whether the deal would trigger credit default swaps. Because of the interest rate dipping below 4% (it would increase to over 4% over time), many observers believe that it will not be voluntary, meaning that CDS will trigger. The rating agency Fitch was prepared to say that CDS should get triggered even if the bond holders believed the deal to be voluntary. So I’d prepare for some chaos after that event, and possible contagion into neighboring Eurozone countries.

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David Dayen

David Dayen