The Greek debt dance heating up

@CNNMoneyInvest January 17, 2012: 12:56 PM ET
Greek Finance Minister Evangelos Venizelos will try, once again, to work out a compromise on Greek debt to save the nation from default.

Greek Finance Minister Evangelos Venizelos will try, once again, to work out a compromise on Greek debt to save the nation from default.

NEW YORK (CNNMoney) -- The financial fate of Greece hangs in the balance this week, as officials reconvene over the contentious topic of Greek bonds, or more specifically, how big a writedown private investors are willing to take.

Greek government officials and the group representing private sector investors and banks plan to resume talks Wednesday after briefly hitting the 'pause' button late last week.

European leaders reached an agreement back in October that included a voluntary writedown, or haircut, of 50% on the value of Greek bonds. That would be equal to €100 billion, helping to reduce the nation's debt to 120% of economic output by 2020.

But the fiscal health of Greece has deteriorated even further since October, raising the possibility of even bigger haircuts.

Europe can't catch a break

"The goalpost has moved since then, and they're demanding a higher haircut," said Nick Stamenkovic, fixed income strategist at RIA Capital Markets in Edinburgh, Scotland.

There's a lot of opposition.

A 50% haircut would slice the nation's debt in half, according to Christian Schulz, senior economist at Berenberg in London. From the bondholders' perspective, the reality would be even more dramatic.

The lower interest rates accompanying the proposed haircut means that a 50% reduction would wind up being more like a 70% reduction for bondholders, explained Schultz.

And even getting the ECB to agree to the 50% cut will be challenging.

"The ECB is the biggest holder of Greek government bonds," said Stamenkovic. "They're reluctant to take a higher haircut because that would trigger another round of contagion."

The ECB plays an important role in propping up the European bond market with its aggressive participation in buying government debt at weekly auctions. The size of the ECB's holdings in Greek bonds is not publicly known, but it seems to be significant enough to fuel the bank's opposition to a higher haircut, and a weakened ECB could spread weakness throughout Europe.

Greece could offer an incentive in the form of coupons backed by a stronger institution.

"The incentives, or sweetness, for the banks is that you get to exchange your Greek bond for something that is backed by the [European Financial Stability Facility]," said Schulz.

S&P downgrades 9 eurozone nations

The EFSF, Europe's bailout fund, was recently downgraded by Standard & Poor's. But even with that downgrade, the EFSF is still stronger than Greece, and definitely more stable.

Furthermore, officials from the International Monetary Fund, European Commission and ECB -- collectively known as the troika -- have returned to Athens to sift through Greece's finances. Officials were reviewing various technical issues Tuesday, with the more prominent meeting scheduled for Friday.

The timing of these debates is important. Greece is going to need a break by March 20, the deadline for its €14 billion payment.

"If they don't have an agreement by then, it's a full blown default," said Stamenkovic. "Greece is going to run out of money."

While the bondholders are holding back on raising the haircut, they could be playing a dangerous game of all-or-nothing.

"At the moment, they're getting 50% back, but if they can't reach an agreement, they'll get nothing," said Stamenkovic. To top of page

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