‘S&P Declares Greece in Default’ (Wall Street Journal) – ‘The Greek Default Begins (Sky News) – ECB Puts Greek Banks On Emergency Aid After Downgrade (Reuters)

ECB puts Greek banks on emergency aid after downgrade (Reuters, Feb. 28, 2012):

Greece’s central bank is likely to step in to smooth funding for the country’s banks after an earlier-than-expected downgrade of the nation’s credit rating prevented them from borrowing against Greek government bonds.

S&P Declares Greece in Default (Wall Street Journal, Feb. 28, 2012):

Greece became the first euro-zone member officially to be rated in default, 13 years after the single European currency was adopted to strengthen the European Union.

Standard & Poor’s cut Greece’s long-term credit rating to selective default from double-C. The move was expected, as S&P said this month that it would consider Greece in default if it added “collective-action” clauses to its sovereign debt, effectively forcing all bondholders to accept a bond-swap offering. …

The Greek Default Begins (Sky News, Feb. 28, 2012):

The talking is over; it is finally happening. For the first time since World War Two, a developed nation is going into default.

That’s the significance of the events of the past 24 hours, with Greece’s debt being classified as in “selective default” and the European Central Bank banning it from its cash window. Months of planning by both banks and policymakers have gone into ensuring that Greece’s negotiated default will be a smooth painless process. We are about to find out whether that planning pays off.

Now, we shouldn’t be surprised by Standard & Poor’s decision to cut the rating on Greece’s sovereign debt from CC to SD (which stands for “selective default”). The ratings agencies had always said that, given private investors are about to lose just over half the value of their debt (through a complex bond swap), this downgrade would be a natural consequence.

Nor should we be shocked that the ECB says it will no longer accept Greek debt as collateral: in fact, the only surprise is that it’s taken this long – on the basis of the ECB’s previous policy, the bonds should have become ineligible when were first downgraded from investment status two years ago.

In the coming weeks we’re likely to learn whether the credit default swaps on Greek debt (opaque insurance contracts) will be triggered. That decision is taken by a committee of bankers and investors convened by ISDA, the International Swaps and Derivatives Association, and they’re due to decide by tomorrow evening whether to start this formal deliberation process.

But as far as analysts and bond investors are concerned, even if they eventually decide it is, as they call it, a “credit event”, this shouldn’t necessarily be a cause for panic. The total amount investors stand to lose if these CDSs trigger is a “relatively small” $3.2 billion, according to ISDA’s wonderfully caustic blog.

Now, you could be forgiven for feeling a little sceptical of the rictus grins worn by the eurocrats and investors responsible for the above information. After all, we’re now officially in the process of the first Western sovereign default in six decades; is everyone really so sanguine?

Actually, no. Because there are so many things in the managed default process that could go deeply, horribly wrong.
To take just three:

1. The process of CDSs being triggered could nonetheless hold some surprises in store. This ISDA system of determining credit events is still only a few years old. This will be its first big test. And what if the committee actually decides this isn’t a credit event. According to Felix Salmon that could be even more disruptive.

2. Many analysts assumed in the run-up to the Lehmans collapse in 2008 that investors were prepared for just such an eventuality. They weren’t. While thousands of hours have been spent investigating the chain reaction that a CDS event could cause in the sovereign bond market, there will almost certainly be some kind of financial impact (eg someone unexpectedly losing money) .

3. The managed default hasn’t actually happened yet. Private bondholders have yet to swap their investments with the 53.5%-reduced bonds they are supposed to get in exchange. It is quite conceivable that not enough of them offer up their bonds, which could in turn trigger a messy default (Greece simply not paying interest on its bonds) and the country not receiving its next bail-out cash. This would then potentially trigger Greece’s ejection from the single currency.

So perhaps the talking isn’t quite over yet. And big question marks still remain over whether this grand experiment in managed financial disappointment will work. So far, based on the sanguine attitude of investors and the behaviour of markets this morning, things are going according to plan. But, this being Europe, don’t expect the calm to last.

Leave a Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.