Understanding Greece's Bond Swap Deal

By Salon Staff

Published January 18, 2012 5:54PM (EST)

The Greek government has resumed talks with its private creditors in Athens in the hope of sealing a debt relief deal needed to avoid a disastrous default.

The country's government in Athens needs to clinch the agreement quickly to qualify for more bailout loans before it faces a massive debt repayment. Without the bond swap deal, Greece will be cut off from its rescue loans.

Here are some questions and answers about the current round of talks:

Q: What are the main points of the potential deal?

A: Private creditors would accept a 50 percent cut to the face value of the Greek bonds they hold. That would be achieved by swapping their existing bonds with new ones with a longer maturity period and possibly lower interest rates.

Q: Why is this deal so important?

A: Greece's debt obligations are so large that it cannot afford to pay them, even if it gets a promised second package of bailout loans. On March 20 it faces a euro14.5 billion bond repayment, which it cannot afford without help. The private creditors' deal will reduce Greece's privately held debt by euro100 billion ($128 billion) and extend the repayment times, giving it vital breathing space.

Q: What happens if it fails?

A: Greece would almost certainly default on its debts, probably on March 20. Greece's rescue creditors — fellow eurozone countries, the European Central Bank and the International Monetary Fund — have said they would give Athens no more support if the PSI deal is not reached.

The PSI deal is essential if Greece is to get a second, euro130 billion bailout from its fellow eurozone countries, the ECB and IMF. A Greek default would threaten the country's position in the 17-nation euro, spread the crisis rapidly to other eurozone countries by making it harder for them to borrow money on international markets. That would endanger the joint currency itself.

Q: Why would private bondholders agree to take such a big loss?

A: Because it is clear Greece can't repay the full amount, and if the country defaults they risk getting nothing. Many might also hold debt from other eurozone countries, which they do not want to be affected.

Q: Must the deal be voluntary?

A: The success of the deal relies on the vast majority of private creditors agreeing voluntarily. If the deal is imposed against their will, it could trigger the payment of credit default swaps (CDS), essentially insurance against a default. Those payouts could be huge and destabilize global markets.

Q: What if there are some bondholders who don't want to sign up?

A: Greece could chose to include collective action clauses, or CACs, into their old bond contracts. Those would stipulate that if the majority of bondholders agree to a debt relief, the deal becomes binding for all and so prevents a minority of creditors from derailing an agreement. The inclusion of such clauses in the bonds will not necessarily trigger the payment of CDS, though using them could.

Q: Why would someone want to derail the deal?

A: Some hedge funds and other private creditors have invested in credit default swaps and so would stand to make large profits if Greece defaults. The decision to trigger CDSs is made by the International Swaps and Derivatives Association, based in New York.

Q: How much money does Greece owe?

A: Greece's national debt, which is two-thirds owned by private creditors, has reached some euro350 billion, or more than 160 percent of annual economic output. That's not sustainable without an agreement with banks and other debt holders.

Q: Aren't the austerity measures helping?

A: After two years of punishing austerity, Greece's government is still running at a net loss. It has promised the EU and IMF it will achieve a so-called primary surplus — a budget surplus when not counting interest payments on loans — in 2012. But that requires a successful PSI deal being reached.

Salon Staff

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