Thursday, March 8, 2012

That's Why They Aren't Calling It a Default - UPDATE: It's Official

I earlier had said that the Greeks were essentially defaulting by giving their creditors a "haircut." However, there has been a great reluctance on the part of anyone except Moody's and S&P to call it a default. I thought it was just political correctness and a mistaken belief that it would spook the markets if the politicians uttered the d word out loud. Turns out there's an insurers vs banksters sub-plot in this whole deal. From the Telegraph:

Europe has ring-fenced Greece's debt crisis for now but its escalating recourse to legal legerdemain has shattered the trust of global bond markets and may ultimately expose Portugal, Spain, and Italy to greater danger.

Athens officials last night estimated more than 85pc of private creditors had accepted the €206bn (£173bn) bond swap shortly after a deadline expired yesterday evening. That is enough for the deal to go through, but leaves the possibility the government might have to use its controversial Collective Action Clauses (CACs).

Ratings agencies have warned they will declare a default if Greece activates the CACs, which allow the government to impose the deal on the remaining bondholders. The CACs will be used if the take-up falls below the desired 95pc but above the required 66pc.

The International Swaps and Derivatives Association (ISDA) is poised to convene again to decide if the deal amounts to a “credit event” that would trigger billions of euros of insurance.

If the event isn't called a default or "credit event" then the insurers are out billions of euros, but if its just a "haircut" then the insurance isn't triggered. This seems like a bad system, as a huge incentive is built in to game the system. Or should I say, yet one more incentive is built in to game the system.

Ambrose Evans-Pritchard calls out the whole enterprise for what it is, legal skull-duggery. He points out that the European Bank has exempted itself from losses on the Greek debt, in effect shifting debt on to other bond holders. (Governments interfering in bankruptcy's favoring certain groups, I could swear that sounds familiar.) Here is an extended quote (I don't normally like to do that, but he is very clear and its important.)

The rule of law has been treated with contempt," said Marc Ostwald from Monument Securities. "This will lead to litigation for the next ten years. It has become a massive impediment for long-term investors, and people will now be very wary about Portugal."

At the start of the crisis EU leaders declared it unthinkable that any eurozone state should require debt relief, let alone default. Each pledge was breached, and the haircut imposed on banks, insurers, and pension funds ratcheted up to 75pc.

Last month the European Central Bank exercised its droit du seigneur, exempting itself from loses on Greek bonds. The instant effect was to concentrate more loss on other bondholders. "This has set a major precedent," said Marchel Alexandrivich from Jefferies Fixed Income. "It does not matter how often the EU authorities repeat that Greece is a 'one-off' case, nobody in the markets believes them."

Anybody for some Portuguese bonds? So given this history and this administration's abysmal record on the rule of law, what's going to happen when Illinois or California head towards default of their bonds? I believe the class already knows the answer. But for added emphasis, we have the previous story of the U.S. Treasury guaranteeing interest on California state bonds. Just as perverse incentives are at play in the EU shenanigans, so too, will this cause the Fed to buy up state bonds should that day come. Of course, by concentrating all of the financial risk of every government entity onto the U.S. Treasury, the meltdown will be all the more spectacular.


The WSJ is reporting that the "special committee of the International Swaps and Derivatives Association, which rules on such matters for the credit-default" has indeed ruled that the Greek action is a default which triggers the insurance provisions discussed above.
Payouts on a net $3.2 billion of insurance-like contracts designed to protect against losses on Greek sovereign debt have been triggered, after the country forced certain private creditors into its debt restructuring who didn't want to accept the terms of the deal, a committee of dealers and investors decided Friday.
Now that the EU Central Bank has insulated itself, and we have a real life actual sovereign default, what will happen to other sovereign debt interest rates in the euro-zone? Here is what we have so far:

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