Peter Tchir

If you are going to «play the wild and crazy guy» scenario – every once in a while you have to act «wild and crazy»

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James Dean


Much has been made of the «Game Theory» behind the Greek Debt Negotiations. It is complex as it is not just Greece versus Germany, but other countries have a say, and then there are the purely EU level politicians, making this all very complex.

I have been thinking a lot about one of the classes I took in college that had some element of «Game Theory» to it.

The most basic and simple game is that of «chicken» made «famous» by the movie Footloose.

You and someone else line up two cars and drive straight at each other. The first to swerve «loses». If you swerve first you lose some dignity. If neither of you swerve, you are potentially dead. So the «real» losing situation is neither party swerve.

So there are only 3 outcomes – you swerve first (small loss), they swerve first (gain), neither swerve (big loss).

So what you really want to do is make sure the opponent swerves. The «best» way to do that is to convince them that you cannot swerve.

For example – locking the steering wheel in place, putting a brick on the gas peddle, and then sticking your hands and feet out the window would go a long way to convincing your opponent that you aren’t going to swerve. That should, with a rational opponent, convince them to swerve since you have eliminated the option. The fact that the analogy was regarding U.S. policy in the Middle East at the time and may not have accounted for irrational players, is a separate issue.

So here we are back to Greece.

I have believed that Greece and Germany both ultimately want to come to a deal that buys time (a couple of years). Greece can say they will pay the full amount (just over an incredibly long period of time with low interest rates) and get some relief on the near term austerity while promising to be good in the future.

Something along those lines seems to be a rational outcome.

But Greece probably needs some form of market disruption to get what it wants. How can Germany give in when the market is telling them every single day that not giving in shouldn’t cause a problem.

Greece for its part, has time and time again said they need better terms, and then always, at the last minute, signed up to whatever deal had been on the table all along.

So Greece’s past behavior indicates a deal should be reached almost no matter what. The EU, when it has relented, has typically only done so when the markets have held their feet to the fire, which we aren’t seeing this time around.

So Greece has just under 600 million Euros due as interest on the PSI bonds (the chart below has monthly Greek debt payments for the next year):

Greek Bonds

They can be good borrowers and pay that and continue to go back and forth with Europe over the 6.1 billion Euros due in March. But what fear do the lenders really have? The t-bills will roll no problem (or at least they have always done so). One part of the Troika will likely «lend» money to Greece via a lock box to pay the IMF loan. So where is the threat? What makes Germany come to the table?

On the other hand announcing a default on the PSI bonds on February 24th could shake up the players.

Yes, the PSI bond holders have had to bear the brunt of the prior Greek defaults, but now, for the first time, Greece would have gone «off script.»

If you are going to «play the wild and crazy guy» scenario – every once in awhile you have to act «wild and crazy.»

The nice part about defaulting on the coupon payment, is there is a 30 day grace period.

So these bond holders can call it an Event of Default until 30 days. I have not looked at the cross default language in other bonds, but I suspect that most other bonds and loans could not trigger cross default language until such time as these bonds were actually in default.

Now you are sitting at the table with the clock ticking. Not only have you already not paid a payment when due, you have the grace period clock ticking. The March payments are principal payments which typically have little or no Grace Period.

So now Germany and the rest of the EU is sitting across the table from someone who has acted, and threatened to make every bond due and payable. They have also demonstrated a willingness to not pay debt of their own accord.

The Spanish and Italians might start wondering where they are going to come up with as much as 70 Billion Euros to cover all of their commitments related to Greek debt.

They might see compromise as the better part of valor (or in this case, to stick to the lingo, they might swerve).

The nice part about this, is if a deal is reached within the 30 days and before any debt maturities, it could be «cured».

So this is a highly UNLIKELY scenario, but so far Greece isn’t getting its way, and seems to be running out of options (other than looking very weak domestically and sticking to the same gameplan that hasn’t worked for years). So what will a Game Theory Finance Minister do?

Is there any investment advice around such a low probability scenario? Sadly, no.

But, when the market grows complacent (VIX back to 15) at or near all-time highs, it sometimes is worth sitting back and figuring out what could go wrong, especially when it may be in someone’s best interest (Greece) to make things go wrong.

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