In The News: Greek Debt Negotiations 1.24.12

Greece has experienced the worst debt troubles of any European nation, and its debt burden is clearly unsustainable. European officials and bondholders both want to avoid a default, so they have been negotiating a “voluntary” agreement to reduce Greece’s debt burden by 50%. As usual, though, the sticking point for the two sides is price. In the case of bonds, this means the yield on the new bonds. Bondholders want the highest possible yield. A higher yield means higher debt payments, however, and Greece will require financial aid from the IMF and other European Union countries to make the payments. A default would trigger many costs and raise the level of uncertainty for investors, possibly raising yields for other European countries, which gives bondholders some leverage. On the other hand, if the Greek government defaults, there is little reason to give bondholders anything. The lack of progress has caused a flight to safety, which has helped relatively safer investments, including US mortgage-backed securities (MBS). Mortgage rates are largely determined by MBS prices, and a “messy” deal or a default would likely cause US mortgage rates to move lower. If bondholders agree to a deal at a yield which Greece can handle comfortably, then investors may partially reverse the flight to safety trade, leading to higher US mortgage rates. The negotiations have been going on for months, and it’s not clear what will break the impasse. Meanwhile, US financial markets continue to be influenced by the news from Greece.