Foreign Affairs

Greece defaults

CNBC reports that the long-anticipated “haircut” for the poor saps who purchased Greek debt was administered with a chainsaw, triggering what is delicately referred to as a “credit event”:

A group representing dealers in credit default swaps decided Friday that Greek’s bond swap constitutes a “credit event” that entitles holders of Greek credit default swaps to compensation.

The “yes” vote by the International Swaps and Derivatives Association triggers roughly $3.2 billion in CDS, which are insurance policies that pay out if a bond issuer defaults. That amount is actually much smaller than many had feared.

The decision was widely expected, and stocks were slightly down after the announcement.

Greece pushed through a bond swap deal on Friday, forcing bond holders to take a significant “haircut” on the return of their money. The swap was approved by about 84 percent of the holders, and Greece is moving to activate a rule forcing the rest of the bondholders to go along with the deal.

The triggering of that rule, known as the Collective Action Clause, is what prompted the ISDA to decide that Greece has created a “credit event.”

Evidently the government couldn’t find enough takers to make this process voluntary.  What happens next?  Business Insider explains:

That will lead to payouts of credit default swaps—essentially, insurance contracts on holdings of Greek bonds under Greek law—that investors purchased to hedge against the risk of holding Greek sovereign debt.

While expected, this is the icing on the cake of the first developed market default in 60 years.

An auction related to outstanding CDS transactions will be held on March 19. The committee asks that any investor wanting to participate in the auction notify ISDA immediately.

This morning, Fitch Ratings downgraded Greece to “restricted default” status, which – in combination with the afternoon’s “credit event” – leaves the nation suspended on the precipice between a controlled crash landing and total collapse.  The next step down is “disorderly default.”  Given that the “orderly” version has thus far involved violent riots and burning buildings, that doesn’t sound like somewhere Greece wants to go.

On Thursday, Reuters columnist Neil Unmack discussed the chilling possibility that orderly default might prove to be worse than chaos in the long term:

Once collective action clauses are agreed on, credit-default swaps will be triggered. Even if a chaotic default is avoided, the swap will leave a bad taste in bondholders’ mouths. Private creditors will be forced to take a loss, whereas public ones will be spared.

Ironically the bigger source of concern for bondholders might not be that the restructuring will be chaotic, but that it will prove too orderly.

This might encourage euro zone officials to try it again for other troubled peripheral states, particularly Portugal. Taboos, once broken, aren’t taboo any longer.

And Portugal, once broken, won’t be Portugal any longer.  This morning, during happier hours when Greece looked marginally less doomed, CBS Moneywatch took a look at the other basket cases of Europe:

The Spanish economy is in terrible, terrible shape. Its 23 percent unemployment rate is the highest in the EU. Not a single family member has a job in more than 1.5 million Spanish households. Nearly half of all adults under 25 are unemployed. According to Reuters, Spain is home to a third of the unemployed in the 17-nation euro zone. More than a quarter of the Spanish population is at or below the poverty line.

That won’t change anytime soon as the government is awash in debt. The official total public sector debt is about 70 percent of GDP. But that’s really only a partial total. Edward Hugh, a Barcelona-based economist, says it leaves out the unpaid bills of central, regional and municipal governments, the debts of public enterprises and public debt held by the state pension fund. That totals another 17 percent of GDP. (Mind you, that is still less than America’s debt of roughly 100 percent of GDP.) Spain’s debt will increase by $79 billion – or 6 percent of GDP – this year alone. The economy is expected to contract by 1.7 percent this year, which will more than take care of last year’s slight expansion of less than 1 percent.

Next door Portugal is doing only marginally better. The unemployment rate is a mere 14 percent. The government estimates unemployment will average about 13.6 percent in the coming year. Nearly everyone else thinks that’s crazy optimistic because of the huge austerity measures which are about to kick in.

Those measures cut the government budget deficit from 9.8 percent of GDP in 2010 to about 4 percent by the end of 2011. While this made the folks at the EU signing the bailout checks happy, it should be noted that Lisbon was only able to hit that number because it moved all pension funds held by banks into government coffers.

(Emphasis mine.)  Whoops, did I say “basket cases of Europe?”  We are all Europe now.

Portugal’s problems are made worse by a contracting economy, which magnifies its swelling debt against falling GDP.  Anti-growth economic policies are the most dangerous possible indulgence of heavily indebted nations.  Economic weakness swiftly erases the menu of options for dealing with a debt crisis.  Hopefully next year we’ll have someone in the White House who understands that.

Sign Up