If You Can't Find The Fish At The Table

There is a saying in poker “if you can't find the fish at the table, then you're it.” And right now, when it comes to the Euro Crisis, no one thinks they are the fish. 

The amount of brinksmanship taking place in global financial markets has reached a fevered pitch more akin to the Word Series of Poker than the implementation of global economic policy. Depending on whom you listen to (or want to believe): 

1. the Euro crisis has been contained and financial markets are on the verge of a renewed bull market because of improving economic data and the amount of cash sitting on the sidelines, or 
2. Europe is staring into the abyss and heading for the next great depression because of the increasingly complicated financial trickery in Europe and the impending hard default of Greece

The reality, of course, is that both cannot be correct and odds are expectations will continue to oscillate wildly between the two outcomes over the next several months and quarters as the stresses in Europe eventually work themselves out. 

The most obvious place where this game is being played is in Greece where negotiations between the Greek government, the Troika (European Central Bank, European Union and International Monetary Fund), and European banks have been ongoing for months. Simply:

• Greece needs money for interest payments due in March so they have agreed to draconian austerity measures
• The Troika needs the EU to remain stable, so they have agreed to give Greece money even though Greece is a bottomless pit
• Banks do not want the EU crisis to deteriorate further, so they have agreed (in principal) to forgive a significant portion of Greece’s debt 

On the surface, this is THE main event—the stakes are high and all sides appear to be playing to win. 

However, in the last several months, a fourth player has shown up that no one has paid attention to who has the ability to significantly affect the outcome of the game. This player, small yet cutthroat, may be the real shark at the table. 

It appears that a handful of hedge funds have been buying Greek sovereign debt at distressed prices in amounts sufficient to influence the outcome of the restructuring negotiations. While their exact motive is unclear, it is likely they are attempting to engineer one of the following outcomes: 

1. These funds may simply want to force the hand of the Troika by blocking a Greek restructuring until new, more favorable terms are put in place for a quick profit (while the math is significantly more tricky, at the most basic level these funds probably paid around 20 to 30 cents for Greek bonds while they push for a restructured "new" price closer to 50 cents). 
2. The other, more insidious (albeit less likely), motive may be to exert enough pressure that Greece is forced into technical default. By buying CDS (insurance on bonds) that pay out when a country defaults, these funds may be gearing for a much larger win that pays off when Greece defaults (and contagion spreads to other periphery countries). 

Bottom line:  At the risk of remaining overly pessimistic for too long on Europe’s ability to contain the crisis we continue to maintain our negative positioning on the market.  We are prepared to adjust this stance once the details of Greece’s imminent restructuring are clear.

However, in our opinion, as it currently stands, the entrance of hedge funds into the Greek debt negotiations process significantly increases the likelihood that Greece and the Troika will make a policy mistake that will trigger a technical default and more importantly reduce investor appetite for other, more systemically important, European country bonds. 

Case in point, this morning there are rumors that “Greece Nears Deal With Creditors on Haircuts” that would pay only 32 cents on the euro for Greek bonds.  Forcing such a steep loss on all private investors, while good for Greece, may trigger credit default swap payments and at the same time inadvertently scare investors away from other high risk European countries like Portugal, Spain and Italy given the severity of the forced loss.