Sunday, March 11, 2012

Greece Defaults

After months (or perhaps years) of uncertainty, Greece has restructured their debt and therefore defaulted, though some may try to avoid that term.   This will likely trigger a Credit Default Swap (CDS) event.

According to Wikipedia:
Credit default swaps have existed since the early 1990s, and increased in use after 2003. By the end of 2007, the outstanding CDS amount was $62.2 trillion,[4] falling to $26.3 trillion by mid-year 2010[5] but reportedly $25.5[6] trillion in early 2012.[7]

That's a lot of coin.  Nobody knows how much the CDS sellers of Greek debt are on the hook for, since they could be hedged or exposed to counterparties that are also affected by the default.  Perhaps $3.7 billion to $700 billion Euros, give or take?

There was plenty of uncertainty in the markets related to Greece over the last year and the fact that perhaps CDS instruments were not worth the paper they were printed on. (if they were printed at all)   Last year Greece experienced what could only be considered a default, and yet there was no CDS event.  That's kind of like losing a limb and then your insurance company claims you might find it somewhere and decides not to pay.  This week's changes may renew enthusiasm towards these types of financial weapons of mass destruction.

The magnifying glass welded by the trading community will move towards the next ant, focused on burning another Euro-zone country, or maybe a counterparty affected negatively by the Greek default.

The Greek Crisis: Greek debt swap triggers massive payouts: "It means there will be a net $3.2bn pay-out on CDS contracts, according to the data warehouse Depository Trust & Clearing Corp, in a boost for the relatively new market in sovereign debt protection that could also benefit eurozone debt markets amid worries that a failure to trigger could have undermined an important hedging instrument for holding government bonds.

However, there was a long delay over the decision by the ISDA determinations committee, which is made up of 15 global banks and investment funds, that annoyed some investors.

Uncertainty still hangs over the CDS market as an auction process to decide the amount of pay-outs may not take place for another week."

I believe there is an effort to bankrupt some of the world's largest entities, in order to collect CDS payouts, and short the stocks as they fall.  The CDS market is not transparent - there is little regulation though perhaps that is changing as more of these types of actions are revealed.  Like snowballs rolling with an avalanche, the increase in borrowing costs hurt companies and sovereigns, causing borrowing costs to increase and likelihood of debt metrics to rise.  It is an effect that would be tough to reverse, kind of like racking up 28% credit card debt with little income coming in to pay it back.

Banks and funds keep a close eye on risk, and CDS instruments are one of those things that have quite a few different types of risks.   Country risk, liquidity risk, currency risk, political risk, and jump risk.

Jump risk is probably the one risk CDS sellers do not want to see, and CDS buyers are all into.  For a buyer of CDS, this is like winning the lotto overnight, provided the payout happens and doesn't get diluted by overbought coverage.

I wonder if Greece will go the way of GM, a leaner, meaner country.  All of a sudden 70% of the debt gets written off?  The money has to go somewhere.

Their ETF fund GREK was up 23% shortly after launching in December 2011.  According to it's P&F chart, it's in a Descending Triple Bottom Breakdown.

ETFs with Greek exposure.

SEA, a tiny 32M cap fund with one of the largest exposures was down 46% last year.  There was a huge amount of volume in February.  Perhaps there is a correlation to the launch of the iPad 3?  Apparently the iPad is to shipping what Harry Potter was to booksellers.

I don't own any of these funds.

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