Photo: flickr/ duncan
Markets have appeared enchanted by reports coming out of Greece recently that Greek politicians are about to approve a new round of austerity measures and happily ignorant of the fact that negotiations about private sector involvement are still dragging on.But even if the Greek government were suddenly to reach agreements with both the troika and its private creditors, it appears unlikely that both deals will actually be worth anything.
That’s primarily based on the fact that the debt swap deal officials agree to with the private sector will likely never be implemented, particularly if the European Central Bank doesn’t join in on sharing losses. As it stands participation in the plan will have to be “voluntary” in order not to provoke a credit event.
However, investors will fight tooth and nail not to bear the full brunt of the 70 to 75 per cent losses they will likely take under the agreement if they can’t collect on the insurance contracts (credit default swaps) they purchased to hedge against the possibility of a Greek default. Thus there are two probable outcomes:
- EU leaders forcibly prevent a credit event, potentially with a special account for Greece that would essentially would allow Greece to feign the appearance of paying off maturing debts without actually paying them off. In this scenario, the private sector would take a big hit and credit default swaps would not be paid out. This would ruin the CDS industry (at least in Europe) and foster deep distrust for EU leaders.
- EU leaders accept a credit event and let Greece default in a disorderly fashion. This essentially negates the deal that’s happening right now. Theoretically, a disorderly default would result in a deeper cleansing of Greece’s debt burden so the country would not necessarily need all the austerity measures the troika is forcing upon it. However, the consequences of CDS payouts are somewhat vague and its impact could be far-reaching, despite the industry’s small size.
There doesn’t really appear to be a compromise between these two options. True, the ECB could also take a haircut as part of the selective default mentioned in the first scenario, however Greece’s debt burden would still probably be unsustainable even if the central bank took losses.
Even if Greek leaders stomach more austerity and put the country in place to receive much-needed bailout funding, there appears to be no way the debt swap deal will go according to plan.
Thus any Greek “agreement” is ultimately worthless.