Greece = Not Good

[AllentownJake]

Over the weekend it was revealed that around 10 billion euros (13 billion dollars) have been pulled out of the Greek economy in the past month and the EU is not ready to jump in and save Greece (we save Greece where does this stop).

That coupled with fact more and more people are placing bets that Greece will fail with derivatives.
Remember derivatives are little more than unregulated insurance contracts.

Karl Denninger at the Market Ticker rightfully points out that on all other insurance products require an insurable interest in the item being insured. Derivatives have no such regulation. So right now, I could purchase insurance for a Greek default, despite the fact that I have no ownership in Greek bonds.

The reason why you can't purchase life insurance on a stranger or property insurance on property you don't own, is you have an incentive in something bad happening to them.

Greece is at a point, where on excel spreadsheets, it is more profitable for Greece to fail than it is to succeed in avoiding its debt crisis. When this happens, people have an incentive to push them down the stairs.

The secondary problem is that, we don't really know if the people writing the Insurance have the money to pay the policies (think AIG). There has been no new regulation here, so I'm guessing the answer is probably no.

and for those who think this is only a Greek problem....the margin call is spreading to the other PIIG nations and Eastern Europe. Sub-prime crisis with country's sovereign debt. Scary.

http://www.businessinsider.com/the-greek-crisis-spurs-a-global-margin-call-as-confidence-ebbs-2010-2

[Odin2005]

1. This won't end well.

[AllentownJake]

2. It didn't the last time

and I can't think of any good way for this to end.

[w8liftinglady]

3. also Spain and portugal

http://www.washingtonpost.com/wp-dyn/content/article/2010/02/05/AR2010020504411.html

LONDON -- Governments in Athens, Madrid and Lisbon struggled on Friday to quell fears of a looming debt crisis in Europe that is pummeling the euro and rippling across global markets, as authorities vowed to impose fiscal austerity and plug their yawning budget deficits. The problem, however, is that investors don't appear to believe them.

Senior officials at the major rating agencies on Friday played down the risk of an immediate debt crisis, saying even nations such as Greece have enough reserves to put off for months a day of financial reckoning. Yet investor doubts over the will of Greece, Portugal and other nations to right their accounts have sparked a crisis of confidence that is seeping into stock and corporate bond markets across Europe and beyond. It is especially hitting banks and other institutions with broad exposure to the sovereign debt of the "PIGS" of Europe -- Portugal, Ireland, Greece and Spain.

[AllentownJake]

6. It is like what happened with Bear Stearns and Lehman 2 years ago

They were over-leveraged, someone realizes it, the shorting starts, credit dries up, the firm dies, they move to the next target.

[Statistical]

15. There is a big difference. Greece doesn't trade on the markets.

The spiral of doom involved two components.

Pickup lots of CDS at ultra cheap prices.
Short the STOCK of the company.
Rapid decline in STOCK price spooks bondholders who buy up CDS.
CDS rise in price so shorters sell some of the CDS to finance more shorting.
Money from CDS -> shorting stock.
Stock goes lower, CDS rise even more, sell even more CDS to short even more shares.
Repeat selling CDS and shorting stock and until companies share prices collapse.

Rebuy shares and profit.

There is no ability to force Greece's stock down because Greece doesn't have any stock.

[AllentownJake]

23. Greece has Greek stocks

Sovereign Debts, corporations, etc.

You can short an entire country...it is being done

Why are you always defending the Neo-Reagan free market despite all evidence on what is going on.

[Statistical]

26. Value of corporations doesn't affect default risk on Sovereign debt.

You also can't short Sovereign debt.

So that is where you Lehman Brothers : Greece analogy falls apart.

CDS alone are not what allowed manipulators to bring down financial firms.

CDS combined with cash from selling those CDS as they rose combined with illegal naked shorts of equities all combined gave the manipulators the ability to force financial companies into a downward spiral.

Greece stock market decline has nothing to do with the probability that Greece will default on her national debts. By that logic when US stock market declined 70% the spreads of T-bonds should have spiked.

[AllentownJake]

31. There has been a flight of Capital from Greece the past month

If you are a corporation in Greece, that builds things, exports things, or imports things a government default will have a significant impact on your operations.

So a savvy group of investors could even create a crisis if they wanted to, make bets that things will fall apart in a nation that is over-leveraged, start a war on the stocks and companies that employ people in said country, reduce tax collections further, make leverage problem worse, create a panic, investors withdrawal capital from nation, nation has less and less options, buy CDS on debt and take a huge profit.

[Walk away]

4. Thanks for explaining it in a way I can understand.

It's terrifying to think an entire European country could collapse.

[AllentownJake]

8. It will be pushed down the stairs

They wouldn't be having as much trouble if it weren't for the derivatives.

[GoCubsGo]

5. Thank you for posting that.

I wouldn't have known about it otherwise. Our media is too obsessed with the Gimmick right now to report on it.

[AllentownJake]

7. They aren't going to talk much about it

Until there are pictures of riots in the Greek cities.

American Journalism is based on sensationalism, not on providing people with important information.

[northernlights]

10. that could be as soon as tomorrow (tonight in ET)

Weren't they promising strikes against the austerity program scheduled for Tuesday?

[BolivarianHero]

17. They'll strike and they'll riot...

And then come election day, they'll chicken out and elect another faction of neo-liberals.

[AllentownJake]

21. They'll have two neo-liberals to choose from

Not really a chicken out thing.

[BolivarianHero]

39. Really?

Last I checked, there were two viable leftist coalitions in Greek politics who have had electoral success and who have polled as high as a combined 20% (This isn't even counting PASOK, which isn't really any better than New LieBlair or Accion "Democratica").

[dgibby]

34. Ali Belchi (sp?)

talked about this last week on CNN, but you did a better job of explaining it, Jake. Thanks.

[Swede]

9. They'll have to bail them out.

Just to save themselves.




If the crisis worsens, it would fall to European governments to rescue Greece or any other ailing country, such as Portugal.

While wanting to avoid anything that encourages further reckless borrowing and excessive government spending, they have indicated they will do whatever it takes to prevent a sovereign default of a euro member.

http://www.thespec.com/News/Business/article/717936

[AllentownJake]

12. They will end up devaluing the euro

The normal course of action when this happens is for a country to devalue their currency to make the debt payable. Greece does not have that option, so the European Union will have to do it as a whole.

Greece is only 3% of the GDP of Europe, however, when this spreads to the other PIIGS you are looking at 35% of the GDP.

Once you bailout Greece, all incentives for the other troubled nations to do unpopular things go off the table.

There is no happy ending for Europe in this situation, it is a choice of bad, awful, or oh shit.

[Statistical]

13. Which is why Euro has had a reversal and been declining for last month.

Euro Dollar cross peaked at $1.51 on Nov 25 and has been on a pretty much continual decline since then with the slide really picking up steam in last month.

http://www.google.com/finance?chdnp=0&chdd=1&chds=0&chdv=1&chvs=Linear&chdeh=0&chdet=1265643025531&chddm=357679&q=CURRENCY:EURUSD&ntsp=0

A lot of people got destroyed betting against the continued decline of the dollar.

[AllentownJake]

20. At the end of the day

The dollar is backed up by over 3000 nuclear warheads, the world's largest army, air-force, and Navy and has two oceans protecting it's borders and two weak neighbors politically and military.

When Europe and China start coming back to earth, the money always comes back here.

[Ghost Dog]

50. The euro has already floated down nicely (an automatic devluation)

against the currencies of major trading partners. It is not so long since euro at 125 - 130 to the dollar was considered on the strong side for the purposes of trade. The currently falling euro is advantageous in this regard.

[Statistical]

11. "it is more profitable for Greece to fail than it is to succeed "

"Greece is at a point, where on excel spreadsheets, it is more profitable for Greece to fail than it is to succeed in avoiding its debt crisis. When this happens, people have an incentive to push them down the stairs."

How?

You buy a stock someone is selling it. You sell a stock someone is buying it.
There is a counter-party for every trade.

You purchase CDS on Greek Bonds SOMEONE has to sell it to you.

So you purchase CDS, I sell CDS to you.

You "winz" when Bond fails.
I "winz" when bond DOESN'T fail.

You have an incentive for Greece to fail, I have a huge incentive for Greece to survive. The writer of CDS doesn't need Greece to do better just not fail on debt obligation to collect. Your CDS has an expiration and if Greece doesn't fail on debt before that expiration you bought a worthless policy. Of course you can buy another lottery ticket next month, and the next month, and the next one however as long as Greece stays afloat the money only goes one way.... to the writer of the CDS.

[AllentownJake]

14. The CDS market is unregulated

Unregulated Insurance is usually a Ponzi scheme.

See AIG. They never had the reserves to handle the CDS they wrote, and since there has been no regulatory movement, I highly doubt the writers of the current CDS have the reserves either.

On an excel spreadsheet, you are going to be rich, until you take your lottery ticket to be cashed in and find out that the seller of the ticket, has no funds to pay you with.

The side betting on a bailout, probably won't have significant cash to pay out their bets, if it does not occur.

If you don't believe me, see what happened in the Russia crisis in 1998 or he subprime crisis of 2008.

I wonder if Geithner is going to run in this time to pay contracts $ for $ in order to "save the world" of if Rubin can come in and put a voluntary tax on all the firms to prevent a systemic collapse this time.

[Statistical]

16. That doesn't change the fact that there is two sides to every trade.

For every speculator hoping Greece defaults is another speculator who will make billions if Greece doesn't.

I don't disagree that CDS should be regulated. I also don't diagree that many counterparties can't pay (look at AIG) which is further reason CDS should be traded on a market.

If you buy or sell a futures contract or an option there is no counterparty risk. Private person to person investments are hugely risky due to that counterparty risk. Can this person pay if I "win".

However none of that changes your incorrect statement that Greece is worth more failed that not failed.

To holders of CDS that might be true however to writers of CDS the exact opposite is true. Also given the fact that CDS are limited life contracts many CDS buyers are likely to lose a bundle if things don't happen as quick as they expect. With no ability to short Greece "stock" they have no method to speed things up.

[AllentownJake]

19. I'd prefer that there was an insurable interest in derivative contracts

If I had 20 people betting my house was going to burn down, and 20 people that were betting it wasn't, I'd be pretty scared there were 20 people out there with an incentive to burn my house to the ground.

Let the gamblers play with sports and Poker. There is a legal non-destructive outlet for this behavior.

[Statistical]

22. by the same logic wouldn't 20 people have an incentive to watch your house

and make sure it doesn't burn.

To make a profit they don't need your house to go up in value, or even maintain value. To collect their premium they simply need to make sure you house doesn't burn down prior to the contract expiring.

[AllentownJake]

24. I'd rather there not be a war

over whether to burn my house down. I'm pretty sure the 20 on 20 person battle is going to cause some damage to my house and my neighborhood even if it doesn't burn down.

[Statistical]

29. I got no problem with CDS being regulated and having an insurable principle.

I am just saying the statement "it is worth more if Greece fails" is completely wrong.

It is worth exactly the same if Greece fails regardless if they $1B in CDS on Greece debt or $1000B due to the fact that there are two sides to every trade.

[AllentownJake]

32. The people writing the policies

have no intention on paying on them. With the corporate veil there, they've already collected their bonuses on the contracts.

How many people who did this at AIG are in jail, or have even have their bonuses taken away from when they sold the ponzi scheme the year before? How many of them simply left and went to another firm collecting huge bonuses from someone else?

It is a Ponzi scheme for a reason, and the Ponzi schemers aren't even being punished. In fact they'll be rewarded.

I believe John Thain just got another well paying CEO job.

[Statistical]

33. If people writing them don't pay then the people buying them don't profit either.

Once again different sides of the same coin.

[AllentownJake]

35. Yes but the excel spreadsheet is saying you are going to be rich

and the last two times this has happened (1998 and 2008) the governments and central bankers have stepped in and paid the bets off.

Remember that Moral Hazard thing?

If you think regardless of whether the entity you are contracting with on the bet can actually pay it, there is a Bob Rubin or Tim Geithner out there to pay you anyway...you make the bet.

MORAL HAZARD

[Statistical]

36. There will be no federal backstop this time.

US exposure to Greece debt is minimal.
US populist rage over bailouts is at all time high.
People are seeing through the lies of "if we bailout the banks the recession will be over".

If counter-parties fail then speculators will be left holding worthless paper.

If anything that actually might lead to some modest reform (moving CDS onto market, requiring margin requirements, limiting amount of exposure to single CDS, limiting exposure to group of related CDS, etc).

Greece debt is a drop in the bucket compared to mortgage backed securities. The banksters in OBama administration won't be able to swing a "systemic risk" title on this thing.

The thing is I think CDS are actually substantially undervalued.

CDS premium is 400 basis points. 4% of principle. Covers against default in next 5 years.

Say you are holding some Greece sovereign debt. You got 3 choices:
a) sell it on market now for about 50 cents on the dollar = guaranteed 50% loss.
b) hold it unprotected. What do you think risk of default is? Say it is 30%. You have 30% chance of losing 100%.
c) Buy enough CDS to cover principle. You are essentially trading all interest for this year in return for not risking your principle.

Personally I would pick C if I was holding billions Greece debt.

[AllentownJake]

37. No but if a significant amount of these bets

were done through British, French, and German banking institutions there will be a Euro/British central bank backstop.

[Statistical]

38. I doubt it.

If anything Euro central back will end up making the point moot by rolling Greece debt (before default) into some newly issued Euro debt.

However IF Greece defaults nobody is going to backstop CDS. The market is simply too small. Only $40 billion. Not systemic risk and it is unlikely anything but smallest issuers won't be able to payout simply due to the tiny size of Greece debt vs Mortgage backed securities.

Greece National Debt: $309 billion
Mortgage Backed Securities (MBS): $7.5 trillion (just in US).

Total MBS worldwide might be in the $15T to $20T range.

There will be no backstop of Greece debt CDS. I will write a contract on that. :)

Look we actually agree on more than you think. Given the history of counter-party risk and lack of transparency in off-book transactions I think CDS should be moved to public market, with regulation, and margin requirements.

I also think people should need an underlying principle to insure. I think govt should never backstop private bets.

However I just think the problem is much smaller the MBS and thus govt response will be smaller than MBS because of it.

[AllentownJake]

41. Add the other PIIGs

This will move, when Dubai was having problems there was mumbling of Greece. Greece is bear sterns here,

[Statistical]

42. Maybe you are right. We will see however there isn't enough systemic risk

Total value of all debt on the worst 3 is only $1.4 T (Greece, Spain, Portugal).

Also nobody expects a complete "erasure" of debt. So bond holders will get some. Say something crazy like 50% cut in bondholder principle that means $700B in CDS payouts. Now not every bank underwriting CDS will go belly-up. Many will payout. The means the total lost by investors due to counterparty default is likely in the couple hundred billion range. The effect will also be dilluted across multiple countries.

The losses by investors will be substantial if some counterparties fail.
It will be enough to cool credit no doubt but nothing like the trillions upon trillions of CDS on MBS in the United States.

I'll donate $50 to a political cause or charity of your choice if the govts bail out CDS investors due to counterparty risk (ala AIG). Not EU stepping in and buying/converting the debt but specifically taxpayer funds used to pay out CDS investors (people who bet Greece would fail) when the counterparty can't pay.

[lib2DaBone]

18. The Central Bankers had an emergency meeting this weekend in Australia

http://www.news.com.au/business/secret-summit-of-top-bankers/story-e6frfm1i-1225827289543


While we were eating Doritos and watching the Super Bowl.. the Banksters were figuring out their next move.

I don't know what they talked about.. but I bet it had something to do with a world currency..one size fits all.

All those derivatives out there are ticking time bombs ready to pop. Unless they do something....I can see another terrorist event coming by late spring or early summer. If large numbers of people wake up to the fact that we are really in Depression II, it's not going to be pretty.. so we need another 911 to divert attention.

Either that or I can see them cracking down on internet freedom...shutting down the tubes. They can't have real information getting out.

Either way you are correct.. Greece is sitting on a cliff ready to go.. followed by Spain, Ireland, France and a few others. It wont end well.

[havocmom]

25. Derivatives can be like the 'dead peasant' life insurance WalMart buys on employees?

Jesus H Christ, no wonder the global economy is a shambles. It has been reduced to a casino.

Investments are not made on real business ventures (product created or service provided) it's mostly about betting on who lives and who dies. Sure, I could envision major players in that casino tipping odds in their favor. They have the mean$.

That trickle down thing... when do we admit it ain't happening? Thems that gots just get more. They have so much they have to invent games to use the excess.

Reminds me of something I read about as a kid. What was that.... Oh yeah, the gods on Olympus wagering on our fates then hedging their bets by interfering and creating conditions to seal our fates.

Tired of trickle down from Olympus. x(

[northernlights]

40. yes. what do you think the banks did with the bailout money?

the money they were supposed to be lending was instead hoarded or...used to continue their gambling spree.

[NYC_SKP]

27. Why is it that no matter how stupid a thing is, other countries want to copy what the US does?

I mean, didn't we INVENT the whole credit default swap idea?

:shrug:

[JVS]

28. How can I purchase insurance for that?

[Statistical]

30. The short answer is you can't.

CDS are not traded on markets.
They are private contracts between two entities and often involve billions.
One entity write a contract, the other one pays for it.
If you need to ask you don't have enough money to get into CDS.

One non-CDS way to "trade" the Greece debacle is shorting the Euro.
Euro will likely continue to decline against its peers until this is resolved.
Also depending on how it is resolved the Euro may decline further. For example if Euro central bank swaps Greece paper for new Euro paper that will be downward pressure on Euro as would inflating Euro monetary supply to deal with influx of debt.

[On the Road]

43. Other Than Futures and Options,

are there ways to bet for or against the Euro or the Greek economy?

I couldn't find a country-specific ETF for Greece, and can't do options or other non-stock trades in my account.

[Statistical]

44. ETFs (Exchange Traded Funds) which track Euro or Dollar.

FXE is the largest. FXE is positive Euro so strong Euro = rising FXE.
You could short the FXE but a bear option spread would likely be less risky (sell the 140 call, buy the 130 call).
If you can't do options then EUO (Proshares Ultrashort Euro) is an option. It moves 200% in reverse of Euro so watch out on and short term Euro rally. It can destroy your position quickly.

The other way to play it is if you think weaker Euro = stronger dollar then the UUP is an ETF which rises when dollar index rises.
The dollar index is the dollar weighted against a basket of currencies (Yen, Pound, Euro, etc) however Euro makes up the largest component.

The advantage of playing the Euro instead of Greece directly is if this issue is broader and other European countries are under pressure you pick up gains there too. Say Greece turns out to not be that bad but Spain is far worse. Euro still declines.

[On the Road]

46. Thank You

That is exactly what I want to know. Ever since the Asian currency crashes of the late 1990s, I have meant to buy some of these funds low and wait a year or two, but have never managed to do it.

[Statistical]

47. Just becareful currencies have a lot of volatility... also the "double funds"

double short Euro, double long S&P are created using futures contracts and they will lose value over time.

They accurately track movement of underlying asset by 200% on per DAY basis but that doesn't always hold up over longer period of time.

[On the Road]

48. I Have Used Domestic Double Funds a Lot for Short Periods --

always with tight stops. Currency funds not so much, because I don't understand them that well -- I have been expecting the dollar to increase for the last year, but the European situation might speed things up. Or not.

Thanks for the note of caution.

[Statistical]

49. No problem just would hate to encourage someone to take on more risk than they realize

As long as you understand double long or short ETF on equities currencies work pretty much the same.

Personally I am long the dollar index as a hedge against my US equities.

When dollar rises it tends to hurt US equities. Rather than try to time the market and sell it off in anticipation of rising dollar I simply hold the dollar index long at a sufficient proportion to my portfolio that I am pretty much neutral to dollars inverse effect on stock market.

Of course the Euro slide was something I profited from without really planning on it.

[On the Road]

51. Never Thought of Using UUP as a Hedge

But it does seem to track pretty well with negative index funds, although it has been a lot more stable lately than a security like SDS.

I am expecting a gradual increase in the dollar too, mostly due to the perception that other countries as at least as bad off fiscally as the US, but have not generated the degree of negative press or market emotion. That may be changing with the PIIGS situation, though.

[dana_b]

45. really scary stuff

thanks for posting this.