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At Last, A Credible Threat of Default: Too Little-Too Late Eupdate?

posted by Anna Gelpern

At long last, Greece is starting to resemble a normal restructuring--you know, the kind where the debtor just might not pay if it does not get the relief it is asking for. Everyone else has done it this way, including the proverbial opposites, mean Argentina and nice Uruguay--but not Greece.

From the start, Europe's crisis management strategy has revolved around flatly denying the possibility of default within the Eurozone. This strategy has given us record-deep yet voluntary haircuts, bizzarre contortions to exempt central bank holdings, and mass confusion around CDS triggers. But even as it denied the possibility of nonpayment--thereby denying Greeks the smidgeon of agency debtors enjoy at the precipice--Europe failed to proffer an alternative "or else." As a result, creditors might be forgiven for wondering whether the alternative to haircuts just might be payment in full. Next to payment in full, the offer of English law in restructured bonds looks like a pathetic consolation prize (they will not survive the next restructuring anyway).

And so a bunch are threatening to hold out on the eve of Thursday's exchange deadline. This is not the long-lost evidence of creditor coordination problems to support calls for sovereign bankruptcy--presumably, countries that do not default do not file either--but rather proof that if you keep swearing you will pay, people will take you up on it.

Now at last, with 48 hours to go, Greece has (sort of) promised to default if the offer fails. With so much on the line, it feels like we are cutting it awfully close.


The country is unlikely to be able to access the private market once the second assistance package runs out; and its planned fiscal and economic reforms will still face very significant implementation risks.

I think what's going on is the opposite. The holdouts are not playing chicken with Greece in the hope it will pay & not default. I think the holdouts are trying to TRIGGER a default - to get CDS's to pay them out.

You may be right, mt, but anyone counting on the CDSes is living in a fool's paradise. I see three, big issues that need resolved: 1) What are the triggers (and anyone who thinks a flat-out default assures triggering hasn't been paying attention); 2) who are the counter-parties (a good question given the usual CDS daisy chain); and 3) can the counter-parties pay? Each of these is a delay measured in years.

Knute Rife- I have no axe to sharpen in this debate, but I would note that, with respect to your comments regarding Greek CDS, it is quite an amazing phenomenon that you could be stating that people who simply expect the issuers of CDS' will live up to their contractual obligations is living in a fool's paradise.

That certainly wasn't the position of Goldman Sachs and other banks when they wanted to collect on their CDS' fom AIG back in 2008. Now that they are on the OTHER side of the trade, they have managed to manipulate pretty much the entire world's legal and financial establishment to contort things to their benefit, and they have so far managed to produce an outcome that is in an obvious departure from any common sense, equitable, or legally proper outcome.

This has instead been quite a distorted, bizarre and astonishing set of events when it comes to Greek CDS'--events that make a mockery of the rule of law and the idea of "free markets." That is a better description of what has happened than the idea that the purchasers of the CDS' were or are naive. Instead, they have so far been defrauded and robbed, plain and simple.

Franklin Raines: I've been commenting for years now that the problem with CDSes is that they are insurance policies that are treated like like securities. The upstream and downstream trading make the insurance aspect of these instruments a joke, but people keep buying, and regulators keep ignoring. If there is fraud, it begins with the issuing of the paper, and the reason I hesitate to characterize the whole thing as fraud is that I don't see how buyers can reasonably reply on the insurance aspects of the instruments.

Now down the road, when the deals collapse and the CDSes prove to have all the value of a Sharper Image catalog, a new fraud arises that I have no problem characterizing as such. When Goldman and the rest wanted their money and AIG couldn't cover, John Q. Taxpayer got to step in at 100%. Given that every one of the institutional CDS buyers knew it had been booking ash as gold dust, this raid on the Treasury was nothing but a fraud on the public. Given that the EU does not seem willing to step up and similarly cover Greek paper, the only alternative is to drop some serious coinage on Wall Street legal talent and start bleeding the opposition. So long as the public purse remains off the hook for this mess, I have to call myself happy. I certainly can't shed any tears for either side of these CDSes. The issuers may have been working yet another scam and may be the fraudulent gods of our world, but the buyers walked in with their eyes wide shut.

Knute rite, I don't disagree with what you said about the risk of CDs's not paying off. But when you look at the options available to a holder, what better alternative do they have but to try that route? I am sure the typical holder knows Greece is not going to pay off at par. And the holder likely bought well above the 25-30 cents that Greek debt is worth. So what choice does a holder have? Recognize a loss or try to create a situation in which they can wring out a CDS payout? I am sure if the powers that be had said, this is a Credit Event, things would have gone much more smoothly for the Greek private exchange. For the european banking system, idk.

There's nothing wrong with buying an insurance policy, but in the overwhelming majority of cases, CDSes have neither been issued nor purchased as insurance, and all efforts to regulate them as insurance have been met with smack-downs on all fronts. If you buy an insurance policy knowing it's really a security, you shouldn't be surprised when it doesn't act like insurance. If you REALLY want insurance, you should be able to find SOMEBODY out there who will sell you a normal policy. If you can't find anyone, that should speak volumes to you about what the CDS market and the markets it supposedly insures are really all about.

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