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The Gathering Storm

The Gathering Storm. Buchheit & Gulati. My favorite rail company: Hell Rail. Hell Rail - Fun Facts. $3.8 million a day in losses (2010) $13 billion in debt (5% of GDP) $ 1 billion loss in 2008 (revenues of $253 million) 3 different strikes since first half of 2013 itself

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The Gathering Storm

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  1. The Gathering Storm Buchheit & Gulati

  2. My favorite rail company:Hell Rail

  3. Hell Rail - Fun Facts $3.8 million a day in losses (2010) $13 billion in debt (5% of GDP) $ 1 billion loss in 2008 (revenues of $253 million) 3 different strikes since first half of 2013 itself Cheaper to send everyone by taxi (2 passengers to a taxi)

  4. Given finances, how do these companies Survive? • Govt gives it money (by borrowing from foreign banks) • But what happens when Greece’s Debt/GDP balloons? Co. borrows (with guarantee) – Does not count to Debt/GDP • But this game ends with Greek goes bankrupt • No one wants a guarantee from a bankrupt sovereign?

  5. We got Worried – Three Reasons • 1. Greek debt, other than Official Sector lending, was supposed to be disappearing. Instead, it was just migrating into a different animal • 2. No one knew how to restructure these instruments, if there ever needed to be another restructuring. • 3. We suspect that our data is the tip of the iceberg (maybe no more than 5-10% of the total number of guaranteed debt instruments)

  6. Response from our Official Sector Friends • No need to worry - read this from the Debt Managers (July 2011): • The Committee considered making . . . CACs mandatory for . . .[guaranteed] debt [but] . . . concluded not to . . . because . . . they represent only a very small portion of the total euro area governmental indebtedness.  • Plus, 90% of euro area sovereign debt is under local law – just change the law (ala Greece 2012)

  7. But the question for me is – How do I restructure it? • Remember Greece 2012 ? • The key there was that 90% of the bond debt (the $400 billion) was under local law – easy to restructure • So, what about this?

  8. Exercise in class - How do you solve this? • In March 2012, Greece basically tried nothing (they were paid 100%, unless they voluntarily took the haircut) • Next time, it won’t have the money to pay (and there will be a next time). • Time to read the contracts –

  9. This is what the bond looks like – scary words

  10. Page 14 Proton Bank K

  11. The Guarantee Structure (As we see it in the bond)

  12. The Real Structure (in the fine print)

  13. But the key contract is the Guarantee, not the bond

  14. What does Ministerial Decree No. 251235671773 say? • At page 53 of a bond of an altogether different company EFG – It says • Governing Law: This Guarantee . . . . is governed by and shall be construed in accordance with Greek law. • Jurisdiction: The Greek courts in Athens are to have jurisdiction to settle any disputes which may arise out of or in connection with this Guarantee

  15. Implications • In 2012, these Greek guarantees got paid in full • Historically, in restructurings, they have gotten paid in full • That is partly why they have become so popular (plus capital reserve treatment) • Next time, in Greece, maybe not . . . • If you are an investor though, there is a tiny subset of these bonds that have foreign law govern the guarantee too (just like there were a tiny subset of Greek bonds in 2012 that had foreign law )

  16. Criticisms from Prior Talks • This is European Financial Accounting; it is complicated and you don’t understand how it works. There is no problem. • These are fake bonds that you are looking at; no one really bought them – they are all sitting in the ECB as collateral. There is no problem. • These are part of the Euro area bailout packages and the new banking union. Not a Greek problem. Rather, a German problem. There is no problem.

  17. Background • Sovereign bond data, in about 2008, started showing a bunch of guarantees where we couldn’t find documentation; • The last time we had seen this in our data was in the 1880s (Argentine railroads) and the early 1900s (Russian cities and railroads); • Greek debt stock that had to be restructured in 2012 had more guaranteed bonds (36) than any prior restructuring – and it was not obvious how to restructure them.

  18. Comments from prior talks • Don’t talk about it; it is too scary • Many of these are fictional issuances – no one holds them (they are used as collateral to borrow from the ECB) • This is European internal financial accounting; something you would not understand • What about Fannie and Freddie? This is no different.

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