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Why Greek lenders don't like the idea of a haircut
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Steve Chiotakis: The central part of the European Union's deal to solve the debt crisis is a so-called
'haircut' on Greek debt.
That word haircut had me scratching my own head all week -- so I asked Marketplace Senior Editor
and Whiteboard guru Paddy Hirsch to enlighten me.
So he dragged me on a field trip to better explain how a haircut really works. And guess where we wound up?
Mohawk Matt: Welcome to Bolt Barbers, gentlemen. My name is Mohawk Matt, and I'll be your tonsorial specialist today.
Chiotakis: Tonsorial? Nice to meet you, Matt. Hey, this is a comfy chair!
Paddy Hirsch: Hey Steve, I know we're talking about bonds, but try to stay focused here.
Chiotakis: All right, sorry.
Hirsch: So a haircut. That sounds pretty painless, right?
Chiotakis: Sure, I need one myself, actually, Paddy. I'm glad you sent us here.
Hirsch: All right, Matt, if I asked you to give Steve a 50 percent haircut, what would you take that to mean?
Mohawk Matt: I'd say you wanted me to cut off half his hair.
Chiotakis: Whoa, that's OK, I guess -- uh, it'll grow back.
Hirsch: Yeah, your hair may grow back, but if you're a German bank getting a haircut on Greek debt, there's no growing back -- that hair is gone.
Steve's 50% haircut from Marketplace on Vimeo.
Chiotakis: That hair's gone for good?
Hirsch: For good. Let me illustrate -- give me $100.
Chiotakis: Right now, here?
Hirsch: Come on, you know, lend it to me. You know I'm good for it.
Chiotakis: Uh, OK, here you go.
Hirsch: Uh oh.
Chiotakis: Uh oh what? Uh oh?
Hirsch: Mate, I've run out of cash. I can only pay you $50 back.
Chiotakis: What do you mean -- you owe me $100!
Hirsch: Yeah, but I can only pay you $50 back.
Chiotakis: What about next week?
Hirsch: No. Never. You just took a 50 percent haircut, my friend.
Chiotakis: Ouch! That's a 50 percent haircut?
Hirsch: Yes. So imagine how all the banks that lend Greece about $280 billion are feeling right now.
Chiotakis: I would say $140 billion short, I guess.
Hirsch: Yeah, and remember, they're banks who borrow at one rate and then lend at another. So that's $140 billion they owe to other people. So Greece may end up wiping that debt off its books, but that debt still exists. And now their banks have to find a way to pay that money back to their depositors.
Chiotakis: And they don't have that money, I'm sure, lying around.
Hirsch: Well we're not sure. Some may, some may not. We're going to have to see how much money those banks have on reserve, and if they don't have enough, then there's a real danger they could start failing. You know, runs on banks, that kind of stuff. And then it could be Lehman Brothers all over again.
Chiotakis: That's pretty depressing, Paddy.
Hirsch: I'm sorry, mate.
Chiotakis: Haven't stopped me, though, from wanting to get my own hair cut. Hey Matt, just 10 percent off the top?
Mohawk Matt: Why don't we take a little bit off the sides as well?
Pretty simple Simon. I think the loans and trades might have been a little more complex than that. Sure there weren’t a few triple-A rated securities in there that amounted to garbage? Here’s an excerpt from Wiki: In the beginning of 2010, it was discovered that Greece had paid Goldman Sachs and other banks hundreds of millions of dollars in fees since 2001 for arranging transactions that hid the actual level of borrowing. The purpose of these deals made by several successive Greek governments was to enable them to continue spending while hiding the actual deficit from the EU.
Hmmm. That’s a familiar sounding investment model. And this was largely before Papandreou and the Socialists came to power (Oct. of ’09).
Banks didn't buy Greek bonds out of altruism. They probably paid a lot better than US treasuries. So if a bank held a Greek bond for 10 years at 5% and then took a 50 percent "haircut" on the principal, they would break about even for 10 years... about as well as I did in the stock market
Brilliant anology, except that you didn't include any discussion of reserves. Banks have been making piles of money off of Greek and Italian debt, perhaps earning back in interest many times over the principle of the bonds, or loans, and should have adequate reserves to cover losses due to "haircuts". Back to the barbershop, it's as if Greece and Italy have been getting haircuts for years, now they want some hair back to cover their bald spot, but the barber just swept the floor and sent the clippings off to the wig factory, which pays better than Greek or Italian toupes. Or something like that.
