Greek Default Risks Remain

Currency in Crisis

European officials moved the proverbial can down the road, but not very far and there are bound to be unintended, though foreseeable consequences, of the new deal.  

The next immediate focus is on the private sector involvement (PSI) and the debt swap.  Essentially, the IIF, representing the banks, accepted a 53.5% haircut on notional value and what appears to be about a 74% haircut on a net present value basis.  It is not clear how much the IIF really represents the private sector.

Reuters reports that the IIF's 32 members had "at least 44 bln euros in residual [Greek] holdings."  This is about a quarter of the 200 bln euros of Greek bonds believed to be in private hands.  This includes the 18 bln euros of debt that is governed by English law and where some hedge funds at thought to be making a stand.  

The aid package assumes a 95% participation rate in the PSI, which seems unlikely.  Greece will seek to retro-actively insert collective action clauses into existing bond contracts.  This risks undermining the veneer of voluntarism that ISDA appears to be claiming prevents the triggering of credit default swaps.  

As the PSI gets underway, the rating agencies are likely to place Greece in "default" or "selective default" status and while this in itself will not trigger the CDS chain reaction, it may prove sufficient to trigger default clauses in other kinds of securities, including the nearly $100 bln of derivatives in Greece (according to BIS figures). 

It is also not clear how much the Greek package builds a firewall to prevent contagion.  Spanish bill auctions went of without a hitch today and Spanish and Italian bonds remain somewhat firmer on the day (10-year benchmark yields are off 2-3 bp), but Portugal, arguably the next most vulnerable peripheral country, is seeing the 10-year yield rise and the 11 bp increase in the CDS is leading the region today.  

Another potential obstacle is the need for country approval of the agreement.   This may be more contentious than a rubber stamp.  While this is may the case in the creditor nations as whole, it may be particularly true for Germany.  

Note that although Merkel's popularity appeared to be rising her party lost numerous state elections last year, she dealt a stunning defeat in recent days when her candidate to replace the German president refused her offer.  Her beleaguered coalition partner the FDP, joined forces with the opposition Social Democrats and Greens supporting Joachim Gauck, who Merkel previously rejected.  

The official creditors won the battle.  Greece will be given the money so that they can service their debts.  They will have an EC task force embedded into Greece to push for compliance and the escrow-like account ensures a priority to debt servicing.  However, in the long game, it is not so clear.  A Greek 3.0 package cannot be ruled out.