Quote from benwm:
achilles28 - I think one problem with your proposal is that it ignores all of the CDS's that have used to hedge bond positions. Should these all be taken of at purchase price as well? Messy, to say the least..
With regard to Greece, they need to default.
The markets will find a floor and the prudent ones with cash left over will be pick up the bargains. That is, unless the politicians have stolen their money.
The CDS argument is a red herring, in my opinion.
Historically, net CDS exposure after a default is 2%. On 360 Billion in Lehman CDS insured-debt, only 7 Billion was estimated to have changed hands at settlement. Protection sellers and buyers hedge their positions daily and post collateral, which prevents against a large one-time payout - and resulting "domino collapse" - which was the consensus expectation (and mine, as well), albeit incorrect.
For that reason, I think bag holders play the derivative card to terrorize Governments into public bailouts. At some point, the game must stop. Banks are holding private markets hostage under the threat of contagion risk - either via systemic balance sheet losses in the case of sovereign debt defaults or credit default swap exposure.
I think nationalization is the most workable solution. Central Banks buy distressed PIIGS debt from domestic banks, then let PIIGS fail. In the aftermath, in the nearly unthinkable scenario a large commercial bank failed to hedge their CDS short positions in anticipation of the publicized 'cut-off' date of said PIGG and goes bankrupt, the respective Central Bank would nationalize the debt of that insolvent commercial bank. And that's it. Let them fail. CDS Counerparties to the insolvent bank who actually held, say Greek debt, were already made whole by their respective Central Bank. If they were only speculators, they lost the premium. Which is relatively small. The outstanding creditors to that large bank (other banks) would then be made whole on their loans to that bank to prevent balance sheet losses and another credit freeze. Again, in this way, the idiot banks that don't hedge their CDS positions get isolated, contained, sterilized, and liquidated. Yes, there's moral hazard with the bonds, but we're a long way down that road already.
As far as letting the entire system flush and collapse, I agree. I'm a free market guy and all this is bullshit. However, American and European deficits are structural at this point, and systemic banking collapse would hasten a sovereign debt collapse even for countries in the 'worry zone', like the UK, France, America, Canada. This is what all this is about. It's not about Greece or Portugal. But shoring up confidence in global markets, to give the system more time. When America, France, and UK goes Portugal, the entire system will reset and all these debt-fueled Western economies will crash. Like a 15%-20% GDP contraction. Think blood in the streets. But since we're dominated by Keynesians, at least for now, I think this is the best solution. I'm no expert. Thoughts welcome.
