Some Details That Most Commentators On Euro Zone Bailout Don’t Mention

This post is based on comments from

  • John Ward’s The Slog
  • Louise Cooper, of BGC partners and rising TV star, speaking on BBC Daily Politics

who have both pointed out that there are problems with the proposed Euro Zone Bailout (it doesn’t matter which version they all have problems).

First a few definitions

Bond A Bond is a contract to borrow an amount of money and pay interest at set intervals, often every 6 months. The amount of interest payable is often fixed. Usually the amount borrowed is repaid after a set term, say 10 years.

Bonds issued by Governments are referred to as sovereign debt.

Bonds may also be issued by councils (municipal debt) or companies (corporate debt).

CDS A CDS or Credit Default Swap is essentially insurance against default by a bond issuer.

International Swaps and Derivatives Association (ISDA) have introduced standard contracts for CDSs, though parties trading CDS are free to alter these or agree their own contracts.

CDSs are not traded on an exchange and there is no government requirement to report transactions.

This means it can be unclear which banks have written Credit Default Swaps and which banks will be exposed in the event of a Credit Default.

Credit Event A CDS contract will specify (in great detail) what triggers payment of the “CDS insurance”. These are referred to collectively as Credit Events and would typically include failure to make an interest payment, or bankruptcy of the party issuing the bond.
Haircut In the context of the Euro Zone bailout “haircut” means investors accepting they will not be repaid all the money they are owed.

A great deal hangs on whether a haircut is voluntary or not.

It is claimed if the haircut proposed for Greek Debt is voluntary, then it does not count as a Credit Event, which would trigger payout of CDS contracts.

If the Haircut is NOT voluntary then a number of banks, believed to be mainly French and German, would be liable for amounts believed to be 10s if not 100s of billions of euros.

InterBank Lending Banks routinely borrow from and lend to each other.
At the end of a day a bank may have either a surplus or shortage of funds. If it has a shortage it will borrow from other banks. If it has a surplus it will attempt to lend to other banks, and earn some interest.


At a time of great uncertainty, for example banks maybe having to payout billions of euros on CDS contracts, it becomes a great deal less attractive for a bank with surplus funds to lend them to another bank at the end of a day. The borrowing bank may not be their in the morning!

It has been widely reported that as a result of the deal done early in the morning of Thursday 27 October, banks have accepted a 50% haircut. This article from The Slog points out this was not true.

IIF, the International Institute of Finance, has accepted in principle the idea of a voluntary 50% haircut Greek bond holders. But the IIF has yet to put this proposal to its members – the banks.

Louise Cooper, speaking on the Daily Politics, on 26 October made the following points.

1 Directors of a bank have a fiduciary duty to the banks shareholders. This is a legal obligation to act in the best interests of the banks shareholders.

It is not clear that writing off half the money the bank has loaned to the Greek government
is acting in the best interests of the bank’s shareholders.

You may not care about banks or their shareholders, but if you have a pension fund it may well be a shareholder in a bank that holds Greek sovereign debt. So you will be affected.

Directors who do not act in their shareholders best interest are liable to be sued by those shareholders.

Perhaps more thought ought to have been given to fiduciary duty before buying bonds from impoverished countries or writing CDS contracts on those bonds.

2 The EU bailout only deals with sovereign or government debt. It does nothing for corporate or municpal debt.
3 Surely this sets a precedent for Italy, Spain, Ireland and Portugal.

Are they really going to accept Greece having half its sovereign debt written off but none of theirs?

4 A side effect of the operation of France putting money into the European Financial Stability Facility (EFSF) is that France may loose its AAA rating. This will cause France’s borrowing costs to rise.

So France’s borrowing costs will rise as a result of helping to lower borrowing costs in Italy and Greece.

How clearly do you think this has been explained to the French people?

What do think they will do and/or say about it when they realise?

5 How voluntary is the agreement?

As Andrew Neil pointed out the German chancellor had talked in the Bundestag, about war in Europe if there is no EU bailout. How voluntary was the agreement really?

In addition how relevant is a voluntary agreement. It is commonly reported that Greece is now bankrupt, surely this is enough to be a credit event.

It seems a very dangerous precedent is being set, if EU or German chancellor is going to demand that legal contracts are ignored according to their command. It is also more than a little strange for EU politicians to start declaring what is and what isn’t a credit event.

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