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Greece: From Sovereign Nation to the Penultimate Structured Investment Vehicle


By transforming Greek sovereign debt into a structured investment vehicle retroactively, policymakers have now made their ability to manage the situation in the future all but impossible.

Early in my career, I worked in structured finance, helping banks and finance companies create securities backed by credit card receivables, automobile loans, and other consumer debt. At the time, the belief was simple -- by taking a pool of homogenous cash flows and putting them through a series of cascading if/then statements and reallocating interest, principal, and credit losses accordingly among various participants, the overall funding and capital costs would be less than if a bank had simply financed the entire pool as is. Or to use an analogy, by reverse-engineering orange juice back into a can of concentrate and a pitcher of water, there would be benefits for Tropicana.

Needless to say, the 2008 banking crisis showed that determining to whom the benefits and risks fall in structured finance transactions is difficult, and when there is a significant and unexpected shortfall, resolving the competing interests of the various parties – each with its own particular contractual "allocation" – is all but impossible. In a world of nonrecourse, sliced and diced cash flows, when there is not enough to go around, all for one and one for all simply does not exist. It is every man for himself, as my loss is your gain.

Watching the evolution of the Greek "bailout" over the past two weeks, I couldn't help but think back to my days in structured finance. Rather than auto loans and credit card receivables, policymakers now seem to be focused on slicing and dicing Greek tax receipts, establishing a complex series of cascading if/then statements with the clear goal to subjectively reallocate cash flows among the various classes of public and private creditors and even the country of Greece itself.

As one who has repeatedly said that the resyndication of loss is investors' greatest risk today, I can't say that I am at all surprised by the evolution of events, but I am afraid that the introduction of greater and greater levels of financially engineered complexity, particularly on a retroactive basis, now make the situation all but unmanageable.

To look at a chart of the allocation of Greek tax receipts after this week's financial engineering is to see the ghost of crises past. Escrow accounts with "troika" trustees, the European Central Bank's new "super-senior" creditor status, the side collateral agreement with Finland, and the potential interweaving of the European Financial Stability Facility all bring back memories of structured finance and worrisome images of collateralized debt obligations squared. As Yogi Berra would say, it is déjà vu all over again.

In an effort to resolve a sovereign debt crisis, policymakers have merely transformed the country of Greece into the penultimate structured investment vehicle. After what we saw in terms of the competing interests of structured finance creditors in 2008, that would be bad enough. Unfortunately, one of the competing interests in this SIV is the citizenry of Greece; worse, European policymakers have added a new twist by creating the world's first sovereign SIV retroactively.

From here on out, the private debt holders of troubled sovereign nations know that when push comes to shove they will be put through a SIV. Unfortunately, they don't have any idea where in the cascading series of if/then statements their interests will fall and who will be financially engineered ahead of them in line. And as this directly impacts private investors' potential severity of loss on their sovereign debt holdings, neither they, nor in turn their investors, has any idea what the potential impact will be. PSI is now completely TBD.

By transforming Greek sovereign debt into a structured investment vehicle retroactively, policymakers have now made their ability to manage the situation in the future all but impossible. From my perspective, what European policymakers have done over the past two weeks is to put sovereign debt holders in a position not dissimilar to that of US bank equity holders in 2008. So long as sovereign debt holders continue to believe that a country's issues are merely liquidity-related, they will stay, but the moment the issue turns to capital, they will all flee at once. Rather than mitigating future risk, policymakers have created a far greater likelihood of binary sovereign debt holder behavior.

By their actions, European leaders have all but guaranteed themselves a Lehman moment in the future should a second country now begin to fail. Rather than creating an impervious firewall, instead they have created a sovereign vortex. And I truly wish that weren't the case. But actions speak louder than words, and having done what they did over the past two weeks, there is little European policymakers can say now or in the future that will convince debt holders otherwise.
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