Hedge Funds Scramble to Unload Greek Debt

Date: Thursday, January 26, 2012
Author: Landon Thomas Jr., The New York Times

LONDON — So much for that big fat Greek payday.

Hedge funds that loaded up on Greek bonds in the last month — betting on a quick gain — are now scrambling to sell those holdings, fearful that European policy makers will force them to take a deep and binding haircut on the debt.

But walking away from the trade may not be that easy. While the money managers had little problem snapping up the bonds from European banks eager to sell, the pool of potential buyers is drying up.

Hedge funds have few options. Although talks between Greece and its bondholders have stalled, European officials are pressing for a deal by the end of this month. Under the proposed debt restructuring plan, hedge funds and other private sector creditors would have to incur losses of 50 percent or more — whether or not the bondholders agreed.

“I think it’s going to be take it or leave it. And if you do not participate you will get massively beaten up,” said one hedge fund holder of Greek debt, alluding to the unpleasant prospect that if he did not take the deal — and the steep loss in value, or haircut — he would end up with nearly worthless Greek bonds and with virtually no legal protection.

The situation represents a significant shift in how Europe has approached the issue. Last year, when the idea of a Greek debt default seemed a remote possibility, the private sector agreed to a “voluntary” 21 percent loss on its bonds. The fear was that forcing mandatory losses would lead to a disorderly default and scare investors off European debt altogether.

But as Greece’s economic problems have worsened and the need for debt relief has become more acute, Europe, particularly Germany, has come around to the realization that the private sector must take a deeper loss. In a sign of the new direction, the region’s leaders have begun discussions with the European Central Bank on an arcane debt swap that would strip 55 billion euros ($72 billion) of Greek bonds from the central bank’s portfolio, thus removing the possibility that the central bank might share losses with the private sector in a debt restructuring deal.

Now, the smart money isn’t looking so smart. Starting in December, the counterintuitive, go-long Greece bet was one of the more popular pitches made to hedge funds in New York and London. Investment banks — Merrill Lynch was particularly aggressive in recommending the trade, investors say — argued that even though Greece was nearly bankrupt, those who bought the paper maturing in March could double their money when Greece received the next installment of its bailout, due that same month.

The theory was that the bulk of that money would be paid to bondholders to keep Greece solvent, just as was the case with past payments from the European Union and the International Monetary Fund. Greece might well restructure its debt, the bankers said, but added it was likely to happen later and would not affect the March payout.

The pitch worked. In the last month or so, hedge funds purchased an estimated 4 billion euros ($5.2 billion) of beaten-down Greek bonds that mature on March 20.

But the bonds have gone from bad to worse. “There was a lot of volume going in, but not a lot going out,” said one broker, speaking on condition of anonymity. The broker said prices for March 2012 bonds had slipped to about 35 cents on the dollar, from approximately 40 cents to 45 cents.

Brokers estimate that of the 14.5 billion euros worth of these bonds outstanding, the largest holder is the European Central Bank, which bought the securities in 2010 at a price of about 70 cents in an early, ultimately futile, attempt to lift Greece’s failing bond market. The brokers say that 4 billion to 5 billion euros of bonds are owned by hedge funds at an average cost of about 40 cents to 45 cents on the dollar, with some of the larger positions being held by funds in the United States that have large London offices.

“It was a very binary trade,” said one hedge fund executive who listened to the pitch but passed. “If you got paid, you double your money in a month. But you may also look like an idiot.”