Sunday, October 23, 2011

A "haircut" is not a "write-down"!

Ekathimerini writes today that banks have offered a 40% haircut while politicians demand a 50% write-down. The former is nonsense; the latter is wisdom.

A "haircut" is a forgiveness of debt; after having made a haircut, lenders no longer have any claim against the borrower of whatever kind. A "write-down" is a provision in a bank's P+L statement for possible future losses. Should these losses not occur, those write-down's can be reversed in the future. A write-down has no effect on the bank’s continued 100% claim against the borrower.

Both a haircut and a write-down go against a bank's P+L statement. The haircut is irrecoverable; the write-down is not.

The objective must be to get banks to record losses in their P+L by marking Greek bonds to realistic market prices (e. g. 50%). The objective cannot be to force banks to incur irrecoverable losses when the borrower has only had 3 years of crisis.

When banks record these losses in their P+L, their capital & reserves will shrink accordingly and they will need to replenish it (or else close doors). Since most of the banks won't be able to raise that capital in the private market, they will have no choice but to pilgrim with hat in hand to their governments and politely ask them to bail them out (which is the way it should be!). Governments no longer have to run after banks and beg them to accept public funds (which is the way it should not be!).

A “voluntary haircut” would undoubtedly become very tricky from a legal standpoint. A “mandatory haircut” would definitely become a legal mess. In which jurisdiction would it apply? What about a Swiss Family Office which holds, say, 1 million EUR in Greek bonds and insists on 100% payment?

A mandatory write-down is a matter of a directive. The ECB and the Central Banks would direct their member banks – via their banking supervisory institution – that all Greek bonds have to be written-down immediately to, say, 50% of their nominal value. Period. This is the only way one can bring banks to the negotiating table; and in a hurry!

The governments don’t really need to replenish capital with cash. They could pass laws allowing banks a maximum of 10 years to absorb those write-downs. However, no dividends during this period.

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