Europe’s leaders have apparently accepted that Greece will default, although they can’t agree by how much it should write down its debt.
Perhaps someone might try asking Finland?
They seem to have one answer at least.
Interestingly, as part of its deal to get collateral from Greece, the Finnish government has assumed a 40 per cent loss on Greek debt in the event of default. Finland’s finance ministry revealed this point when it published a Q&A on the collateral arrangement last week, although it seems to have escaped wider attention:
(The Q&A also confirms that the collateral had to be structured to avoid triggering negative pledge clauses in some Greek bonds)
If you don’t read Finnish, we’ll try to summarise. Finland is getting €880m worth of collateral on its €2.2bn share of the official loans to Greece. According to the Q&A, the €880m amount covers a hypothetical write-down of the loan by 40 per cent, i.e. the collateral provided will cover the loss and make Finland’s claim up to par. The question of whether the amount “won” by the government was worth the diplomatic price of demanding the collateral has since been hotly contested in Finnish politics, of course. We just want to know where these loss numbers come from.
So here is where it gets strange. The Q&A goes on to say that the 40 per cent figure is from Standard & Poor’s historical data on “insolvency” (maksukyvyttömyystilanteissa). In a 2011 update to their ratings methodology for sovereign default recovery rates, S&P noted that “Our estimate of the historical average sovereign recovery rate is 50%-60%”. Flip a 60 per cent recovery rate round and you get 40 per cent losses. So, we think this is what the Finnish government applied. Interestingly, S&P’s estimates are themselves based on an (excellent) 2005 IMF paper on sovereign debt haircuts 1998 to 2005.
OK — the important thing to understand here is that it’s really, really hard for anyone to gauge losses from a sovereign default. It’s unusual to see governments trying to model those losses, rather than investors. Certainly not in public anyway.
Only, we’re not sure why the makers of the collateral deal would have used general historical data, rather than the expected recovery rates that S&P currently embed in their actual rating of Greece. The embedded recovery rates are in the range of 30 to 50 per cent. Flip it around and you get loss rates of 50 to 70 per cent. Greek bond prices increasingly reflect a 50 or 60 per cent loss, while typical quotes these days for CDS recovery swaps and locks on Greece (these allow trading in debt recoveries) suggest losses in the order of 70 or 75 per cent.
Basically, did Finland short-change itself by accepting collateral good for only a 40 per cent loss? (At least it’s making plans for default though.)
It’s a rare official view of the size of a Greek default, anyway. We’d further point out that, for all the protestations that the losses remain hypothetical, Greece is handing over the €880m to the Finnish government. Therefore at least one sovereign creditor of Greece is already acting on expected recovery rates. Even if you think it’s an insufficient estimate of loss, and it’s ‘only’ Finland, it’s still a strange situation.
Collateral issue and Finland’s standing in the EU – Helsingin Sanomat