The many shades of default

Last night, S&P downgraded Greece to "selective default". This followed on from Fitch's description of Greece last week as in "restricted default". Both passed almost unnoticed, didn't they? No twitterstorms, no flash news reports, no extended analysis. Everyone knew some form of default was going to happen, no-one is at all surprised and it doesn't change anything. Markets have already priced in default anyway. So has Germany, if recent statements from the great and the good are to be believed. There was a short, bored statement from the Greek government last night and a slightly longer and equally bored statement from the Eurogroup president. The first sovereign "selective default" in history is a total non-event. Remarkable how things can change in a few short weeks.

More important is today's announcement that ISDA will decide on Wednesday whether or not Greece's retrospective insertion of Collective Action Clauses (CACs) into existing Greek-law bonds is grounds for a credit event. S&P clearly think it is - their downgrade statement makes it clear that the PSI in their view constitutes a distressed debt restructure. But it isn't their decision.

I find it difficult to see how a 75% net present value (NPV) loss for private sector bondholders can be interpreted as anything other than a default, especially with the element of coercion that the CACs introduce. But ISDA works in mysterious ways, and it is possible that they will find some excuse not to call a credit event. This would in my view be very unwise. As someone posted on a previous blog of mine, "ISDA may call a credit event just to stop everyone laughing at them". If they fudge it this time, they will have no credibility left - and neither will credit default swaps (CDS). Doing everything to avoid CDS trigger destroys its usefulness as a hedge, which to many people is its sole purpose. Remove that, and all that is left is speculative trading of an instrument with a VERY tarnished reputation. How long would the CDS market survive? It really isn't in ISDA's interests not to call a credit event. And there is no doubt markets are expecting it and have already priced it in. There is no reason not to do it that I can see.

Looking ahead, the next key date is March 12th, when Greece expects to have completed the PSI deal. It is not clear at present whether it will get anywhere near the sort of participation that it needs. If it doesn't, then as S&P puts it, "outright default will immediately follow". If it succeeds, then S&P will upgrade it a couple of notches. Big deal, frankly. It would still be shut out of the markets, would still be saddled with a mammoth pile of unsustainable debt and would still be trying to implement measures to reduce its deficit that simply drive its economy further into recession and wreck the lives of its people, particularly the young.

Personally I hope it doesn't succeed. If I could ill-wish the PSI deal, if I could throw some curses its way, I would. I think outright default and exit is far and away the best option for Greece now and the sooner that happens the better for everyone.

But the deal could still be scuppered by other interests. One hurdle was cleared today - the Bundestag agreed to the deal. But other nations have still to decide whether they will support the bailout package. And the IMF seems to be doing its best to undermine the whole thing.

There is no doubt in my mind that the IMF is increasingly irritated with the stance of the Eurozone leadership, and the Germans in particular, regarding the destructive austerity measures imposed not only on Greece but on other countries as well. Recent reports from the IMF, as well as comments from Christine Lagarde, suggest that the IMF would much rather see the Eurozone soften its fiscal stance and adopt pro-growth policies. Leaking the unrelentingly pessimistic Debt Sustainability Report on the very day that the EU leadership were trying to thrash out the details of the deal looks very much like a wrecking tactic. As does announcing AFTER the deal was agreed that it won't contribute any money unless the Eurozone itself (mainly Germany) coughs up a lot more.

The G20 is following the IMF's lead. The Osborne/Geithner double act has made it clear that they will not agree to any more external funding for the Eurozone (and in the US's case, any more funding for the IMF, either), until the Eurozone comes up with a bigger bailout fund. Meanwhile the German coterie still insist that a bigger fund is not needed - at least, not from them. Unquestionably their reason for saying this is due to political pressures at home: a recent poll indicated 62% of the German people oppose any more bailout funding, and Merkel had a hard time getting the current bailout deal through the Bundestag.  This standoff could last for some time, although there are some signs of softening in the German camp. Sales of popcorn are at an all-time high and bookies are offering odds of 9-4 on Osborne/Geithner to win the day.

The trouble is, there isn't any time left. The Eurozone leadership were talking vaguely about more money being made available in April, maybe. That is TOO LATE. If Greece does not raise the money by at the very latest March 27th, there will be a disorderly default and Greece will be forced out of the Euro. I am amazed by the languid language of the Eurozone leadership. Anyone would think they were managing a cruise down the Rhine, not a possible catastrophic collapse of the Eurozone.

The biggest issue in this entire sorry tale has been the political failure at the heart of the Eurozone. Nick Panyatopoulos commented on the "political malaise" in the Northern states. Their complacency threatens the survival of the European project even more than fiscal mismanagement in the southern states. An attitude change is needed from Eurozone politicians. Unless that happens, I fear that the dominoes will continue to fall, one by one, until the whole Eurozone - including the mighty Germany - is brought to its knees. And with it, perhaps, the economy of the whole world.


  1. See comment below via

    << German media reports add that a return to CCC rating for Greece will happen in due course. Btw, the way please note that the progress that Horst Reichenbach and his Task Force are making in what is called the "State-Building" of Greece, is widely reported in the German media.
    Reichenbach is an "old hand" in this type of challenge as he was very much involved in the reconstruction of the East German economy post-German Reunification. I refer to his years at the European Bank for Reconstruction and Development. >>

    Do you think this means that a hard line German view of law and bureaucracy will be imposed? I think I would prefer Cyprus law if I were a Greek.

    1. Hi Tim,

      I heard about the ECB's suspension of Greek collateral after I wrote this post. It isn't quite what it seems though. Greek bond holders will be able to use their bonds as collateral with the Hellenic National Bank instead under the ELA. All they have done is move the collateral risk from the ECB to the HNB, which I suppose makes sense but doesn't actually treat the bonds as the junk they really are.

      S&P indicated that Greece would return to CCC if the PSI deal was successfully concluded.

      I think the game all along has been to turn Greece into a mini-Germany. I don't think there is any possibility of Cyprus law being used instead, because Cyprus itself is also on the list for "German treatment".

  2. The EU politicos and the Ecb are wrapping themselves in knots and creating so many potential black swans that the odds on one of them not making a appearance would be ultimate black swan in itself.

    The joker in the pack is the German constitutional court, they have made it quite plain, this far and not further (last sept) since then they all have gone further and much further is needed. I fancy a full blown German constitutional crisis is on the horizon.


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