Easy Street

The Greek bailout: What all those hedge funds are getting

Heidi Moore Feb 24, 2012

If you wondered why Greece got its 130 billion euro bailout, here is your answer: Greece borrowed a lot of money from investment banks, hedge funds and other financial institutions, and it owes them 14.4 billion euros by March 20.

Today starts the beginning of a 10-day-long adventure: the financial institutions and banks that own Greek bonds will turn in their old bonds and get new ones that are easier for Greece to pay. Then the financial institutions will decide whether they will accept the terms of the new bonds.

Earlier this week, a committee representing the bondholders said it sounded like a fair deal – but, with Greece, you never know if things will stick.

This can all sound pretty arcane, but it’s actually a good insight into how Wall Street works: the concept of “show me the money.” put yourself in the shoes of a Greek bondholder: is this deal good enough to accept? Will Greece get its bailout? We won’t spoil the ending, but…

….Okay, we will. Yes. Greece will be saved. But you can get a pretty good insight into what makes the financial world tick with the explanation below.

Today, Barclays broke down the package in a nice research report. Easy Street translates in a handy Q&A format. 

  • What are Greek bondholders getting?

If I’m a Greek bondholder, I’m trading in my old Greek bonds. Those bonds are mostly maturing over 10 years. I’m agreeing to turn them in and accept a package of three things:

  1. A new Greek bond, which matures over 30 years, that’s worth about 31.5% of the original bond. So:  if I have Greek bonds worth $100, I would get this new Greek bond that’s worth $31.50. Since it matures over 30 years, I wouldn’t get my $31.50 until 2042. Greece promises me a certain interest rate, which I’ll know later;  it also promises to pay me 2% interest until 2015, then 3% starting in 2020, and finally 4.3% more interest after that.  That’s very far in the future, which gives Greece a lot of time to pull itself together. Presumably, by then, I will wear a spacesuit to work on my moonbase, and my money will be transferred into my account through a microchip in my brain. But luckily, Greece will start paying me the principal a little before that – in 2032.
  2. A two-year bond from the EFSF – the European bailout fund. This bond is worth another 15% of the value of the original debt exchanged. So now, for my Greek bonds worth $100, I’m getting $31.50 and $15 – a grand total of $46.50 in face value. This is Europe’s contribution to keeping me happy – or at least, keeping me from losing all my money.
  3. A bond that pays me 1% interest per year as long as Greece’s gross domestic product grows more than some targets set by the committee that decided this in the first place. This extra 1% will make me feel invested in seeing Greece’s economy succeed. For the next 28 years, anyway, which is the limit. However, if Greece doesn’t grow its economy, I get zilch. 

Barclays estimates that the value of my new package is worth 26.6% of my old bonds. Which means I’m losing about 74% of the value of my old bonds. But again: I should be happy, because at least I’m not losing 100% of their value.

  • Wait a minute. If you had $100 in Greek bonds and your new ones are worth $46.50, how are you losing 75% of the value?

Well, the face value of my new bonds are worth $46.50 – in 2042, when I’m supposed to get paid! Until then, I just get some interest payments. So the market tells me how much my $46.50-in-2042 is worth today.  Essentially, the current value of my bonds is whatever the market decides they’re worth, based on my chances of getting paid back and how well Greece is doing. Right now, the market is telling me that my new Greek bonds are kind of risky.  So Barclays estimates that the current value, today, of those new Greek bonds I’m getting is nowhere near $46.50 – it’s really something like $10.90 for the new bond and $14.70 for my other bond – the one from the EFSF bond fund – is probably around $14.70. And throw in $1 for that bond related to the Greek GDP.***

All together, the current value of my whole package comes to something like $26.60 compared to my original $100 – and thus, I’m losing about 74% of the value.

  • Okay, so you know how to add and divide. Fine. But is this a good deal or not?

It depends on how Greece does in the future and all that – but Barclays predicts that the whole package should give bondholders around 26.6% of the value of their original bonds. In the harshest bailout in recent memory – that of Argentina in 2001 – bondholders got 27% of their original package. So the Greek deal is not as favorable to bondholders as Argentina – which itself was a deal so harsh that only 76% of bondholders accepted it. 

Greece will get 100% acceptance, however, even if it’s a better deal.

  • What? How do you know Greece will get 100% acceptance?

We talked to Guy LeBas at Janney Montgomery Scott, who laughed as he called the Greek deal “voluntary.”He told us, “It’s voluntary in the sense that bondholders have an appearance of a choice: ‘We’re asking politely before we force you to.'”

Greece has an entire continent’s financial backing in trying to help it gain its footing and pressuring bondholders to accept less money; Argentina had only itself against the world.

An even better twist: if any bondholders don’t accept the Greek deal, Greece will pass a law forcing them to. The country will make it illegal for bondholders not to accept the offer. But if that happens, the deal won’t be called “voluntary” any more.

  • Who cares if it’s voluntary or involuntary?

Some investors bought credit default swaps that will pay them money if Greece defaults. This is often called “insurance.” Let’s say I bought credit default swaps that will pay me $1000 if Greece defaults on its debt. If the bond offer is voluntary, I won’t get my $1000. If the bond offer is forced – if it’s involuntary – then I get my $1000. This matters because if I collect my insurance, the banks who provided me with the contract have to pay me. And a lot of those banks, especially the European ones, don’t have much money lying around to pay me.

  • Okay. So this has been dragging on for more than a year. How long is all of this going to take to get resolved?

Barclays provides a handy calendary, of sorts. Here’s what to look for.

February 24: Greece makes its offer to bondholders.

March 9: Deadline for investors to decide whether they will accept the deal, and reply to the Greek government.

March 9-12: The official bond exchange for most of Greece’s bonds takes place. Documents fly through the ether!

March 20: Greece pays its 14.4 billion euro bond payment.

Early April:The bond exchange takes place for the rest of Greece’s bonds.

Any other questions? Add them in the comments below.

***I clarified that paragraph to break down the bond values more easily. Thanks to reader Chris, below. 

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