Greece: Why Not Just Call It A Default Now?

by: Steven Bavaria

Alice in Wonderland is alive and well in Europe, where politicians and bank officials seem to think that they can call a 50% haircut by banks that own Greek bonds “voluntary”. This is even though they all know that if they don’t – as a group – go along with it, the whole deal will collapse. If it’s voluntary, the thinking goes, then it won’t count as a “default.”

Not having it count as a default, in turn, means it won’t trigger billions of dollars worth of credit default swaps, which are the credit derivatives (i.e. insurance policies) that many banks and other creditors have used to shift their Greek credit risk onto other investors (the way casualty insurance companies use the re-insurance market to offload their underwriting risks.) That means the losses would remain among the relatively small group of original lenders and holders of Greek debt, and not be spread around the much larger set of investors who took on pieces of that debt via the swaps market.

Suggesting a scenario like this is, in a word, ridiculous. First of all, “default” is defined – by the ratings agencies and in the swap contracts – as including not only a straight out failure to pay, but also any sort of involuntary restructuring of the debt where you end up with less than 100% of what you started with. And the ratings agencies look at the substance of the transaction to see what is “involuntary.” Saying you are doing something “voluntarily” while you have a gun at your head doesn’t meet the test for voluntary. And knowing that if you don’t go along with the deal and it therefore craters and you will be held up to public criticism as the institution that caused the failure- well, that’s the 21st century equivalent of having a gun at your head.

Beyond that, there is another reason this deal makes no sense. Even if the banks and rating agencies could be convinced that this deal were voluntary, do you think all the people holding swap contracts where they bought protection on Greek debt are going to just cheerfully accept that there was no default? You will probably have decades of litigation in European and international courts over this issue, the meaning of “default,” whether these swap contracts were triggered or not, etc.

Decades of destabilizing litigation before there is any final word on who really takes the hit for the Greek default (or non-default). Dozens of banks whose own credit position may be in limbo because the effect of the Greek default (?) on them is still unknown. How will that be better than just calling a default a default now, letting the chips fall where they may and being done with it?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.