JPM’s Saul Doctor on Greek CDS

Saul Doctor, JP Morgan research analyst, walks Tom Keene and Ken Prewitt through the complexities of credit default swaps on Greek government debt and why some short Greek paper may actually be a good buy.

Q: Tell us the distinction between actual government bonds and credit default swaps. What is the the relative size of peripheral Europe’s bond market and the credit default swaps on this debt?

A: If you look at the notional outstanding on Greek government or government bonds – CDS on government bonds throughout the western European sovereigns
– and compare the sort of net notional of CDS contracts versus the actual sort of net amount of government bonds that we see outstanding, you are probably looking at somewhere in the region of sort of one to about five percent of the actually outstanding of sovereign bonds, which you see in the CDS market.

Q: Well, how does that compare to the worries that we had over AIG? Is there a parallel or is it a different kettle of fish?

A: I think the outstanding you see in
government bonds is significantly bigger than what we see in the CDS market. In corporates, it is sometimes different. In corporates, you can see up to kind of 20 percent, sometimes even 100 percent of the notional of outstanding bonds. You can see a similar amount in the CDS market. But when you are talking about sovereign bonds, the CDS market is significantly smaller, the volumes are much less, and relative to the liquid government bond market it is just a lot smaller.
It does get obviously a lot of attention and many of the holders of sovereign CDS are fairly vocal in their views. But if you actually look at the numbers, it is a pretty insignificant market.

Q: Should the IMF, the various institutions in Europe manage this crisis focusing on the bonds? Or should they focus on the elites that hold those derivative instruments?

A: It is important to focus on both really.
As I said, you know, CDS is very small. In the case of Greece, it is probably somewhere about sort of one to two percent of the notional outstanding. But the holders of those CDS positions can be fairly vocal in their views. You look at corporate treasurers and how they have dealt with these problems in the past. And in many cases the amount of CDS holders is obviously bigger. But it is a very kind of easy group of people to get onside if you are going through any restructuring offer.
All you have to do essentially is create a CDS trigger and all of those bondholders who also hold CDS against those positions will pretty much be happy to sign up to whatever restructuring you are going to offer because as long as they get their CDS trigger, they know they are going to get asset par. So I think in the government bond world as well, it is worth kind of taking that into account that CDS holders will be encouraged by any restructuring offer that is presented to them as long as they can trigger their CDS contract. At the same time, I don’t think governments are going to care that much because at the end of the day, it is a pretty small percent of the outstanding notional.

Q: This problem with Greece surfaced
about a year ago. Was the market predicting it? Could you see price movement well in advance of the efforts to bail out Greece last year?

A: You saw it both in the CDS and in the bond market. CDS spreads were widening, and government bond yields on Greece versus Germany, for example, were also increasing. To say that one market spotted it earlier than the other, I am not sure. But you definitely saw both markets widening out and showing there was a lot more risk for a default in Greece and other European sovereigns as well.

Q: Would you buy Greek paper here with
those wonderful yields?

A: You’ve got to be a bit careful about
what maturities you are looking for. You know, probably some of the short dated stuff is going to be okay. But the longer dated stuff might see some significant write downs. It is a difficult question at the moment. You are basically taking a punt on European legislators and regulators and how they think the best outcome for Greece and Greek government bonds is.
So it is not really kind of market trading, it is really kind of trying to trade political will at the moment.

(This interview was condensed and edited.)

Bloomberg Brief/Economics 6-22-11

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