Greek haircut

As efforts intended to save the Greek economy continue, the country is increasingly becoming a target for speculators. While banks and insurers see themselves forced to write off increasing amounts of Greek debt, which amounts to 350 billion euros ($460 billion), hedge funds are stocking up on the bonds and investing in insurance against defaults. In other words, they are betting on Greek bankruptcy.

But those insurance mechanisms would not come into play if debt reductions came about by way of a voluntary default, said Hendrik Lodde, an analyst of European government bonds at DZ Bank.

"They would disappear with no effect. It's understandable that many investors would prefer a real default - an involuntary shortfall in payments," Lodde said.

A tall order
That means that many financial players are unlikely to support a voluntary default.

In order to cut down Greek's liabilities by 100 billion euros, well over 90 percent of private creditors would have to participate in the deal. Central banks assume that not enough holders of Greek debt will be prepared to write off 70 percent of their claims against Greece, writes the German business daily Handelsblatt.

One way to force creditors' hands could come by way of the Greek parliament. It could pass legislation forcing private lenders to accept a debt reduction. But several hurdles have so far prevented Athens from writing debt reduction into law.

First of all, lenders, the EU and the IMF, are desperate to avoid passage of such a law because the forced debt reduction it entails could be interpreted by ratings agencies as a disorderly default.

"It's disorderly when everyone hopes that they'll still get something from someone," Lodde told DW.

Credit default swaps on state bonds would also come due. But that does not mean that all holders of the swaps would have to offer payouts. Only those who actually hold Greek bonds would be receive any money.

Ratings game
The response from ratings agencies would also be more unpredictable in the case of an involuntary default, said Jürgen Matthes of the Cologne Institute for Economic Research (IW).

"We've heard from the ratings agencies that, in the case of a voluntary default, Greek bonds would only temporarily be classed as in default," he said.

But with better prospects for Greece as a result of less debt to service, the ratings would quickly recover, Matthes added. That would also mean Greek banks could continue to deposit government bonds as security at the European Central Bank in order to refinance their debt.

An involuntary default, on the other hand, could lead bad ratings to stick with the Mediterranean country much longer, increasing the chances of Greek banks faltering.

Chain reactions

For months experts have warned of chain reactions in the financial markets. The credit default swaps in particular are seen as ticking bombs as no one knows exactly which institutions hold such swaps and how many.
Concerns on that front may be exaggerated, though, said Matthes, "The data that we have suggest that comparatively less volume is in play in terms of the net value of these credit default swaps."

But the absolute number is not the decisive factor when it comes to the damage the swaps could inflict on financial markets, according to Lodde.

"Maybe an insurance company that's not yet on the radar sold a lot of Greek credit default swaps and will get swept down with them," the DZ Bank analyst said.

In such a case, the insurance company might lack enough capital to pay out its credit default swaps, and a bankrupt insurer could then pass on its financial malaise to other institutions.

The markets' choice
But Lodde said he sees an involuntary default as the cleanest solution from the market's perspective "because those who have protected themselves will get something back." And those who didn't - those who made the risky bets - have to deal with the loss.

In order to mitigate the threat of such losses, the European Central Bank and eurozone's central banks have begun a scheme in which they are exchanging their Greek bonds for new bonds. The new bonds would be untouched by an involuntary default.

The European Central Bank wants to avoid the impression that it is financing a state in case it were to lose out on the Greek debt it holds. The exchange scheme also shows that Europe's currency custodian expects a voluntary default to fail.

Author: Zhang Danhong / gsw
Editor: Sean Sinico