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Comment by antimora | Hacker News Reader

is Greece in default or "kind of default"?

I don't see in other headlines news.

There are several different degrees of default, and ratings agencies take into account the severity of possible or past defaults in assigning credit ratings. For instance, Standard & Poor's has the following distinction [1]:

> An obligor rated 'SD' (selective default) or 'D' has failed to pay one or more of its financial obligations (rated or unrated) when it came due. A 'D' rating is assigned when Standard & Poor's believes that the default will be a general default and that the obligor will fail to pay all or substantially all of its obligations as they come due. An 'SD' rating is assigned when Standard & Poor's believes that the obligor has selectively defaulted on a specific issue or class of obligations, excluding those that qualify as regulatory capital, but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. A selective default includes the completion of a distressed exchange offer, whereby one or more financial obligation is either repurchased for an amount of cash or replaced by other instruments having a total value that is less than par.

According to this definition, Greece is SD, and S&P has rated this credit event so.

Felix Salmon is very much a "default is default, even if it means making a coupon payment one day late" kind of person: he is not using weasel words here.

[1]: http://www.standardandpoors.com/ratings/articles/en/us/?asse...

It mentions that they are sort of forcing bond holders to accept a lesser payment. That seems like a kind of default.

Whether they defaulted or not is actually quite key. You see, all the CDS (Credit default swap) holders get to demand the full face value of the Greek debt they hold from the CDS seller if Greece has defaulted. The CDS writers are going to take a huge bath if this happens. This is what took down AIG, except in that case it was subprime MBS (Mortgage backed securities) CDSs that did it.

This is an excellent question--I'm also curious to see how CDSes are affected. Logic dictates the EU would structure this bailout so that, no, CDSes cannot be redeemed, lest we see a bunch of insurers go under as well.

You can bet there are a lot of people making phone calls right now trying to figure this out. My guess is that nobody knows at this point.

If this so-called "selective default" does end up being "structured" such that markets are surprised when CDSs cannot actually be invoked, then that erosion of confidence in the system itself might end up fueling a cascade failure even worse than simple direct failure of some insurers.

If I were worried about this point (and a holder of a lot on CDS 'insured' bonds), I'd get a friend that was immune to 'arm twisting' to buy 1MM of a particular issue, and play extremely hardball with the ECB. Eventually, a payment would not occur, and there would be a solid 'Credit Event' to trigger all the CDS.

NYT: "Holders of short-term obligations would be able to swap their notes for debt with longer maturities and backed by high-rated bonds. An organization that includes most major European banks said its members would accept the offer and expected 90 percent of all Greek bonds to be exchanged. [...] financial institutions that own Greek bonds would effectively contribute 54 billion euros through 2014, largely by accepting reduced interest payments, and will stretch their maturities to as long as 30 years."

I don't understand. Are 90% of Greek bonds truly held by organizations susceptible to arm-twisting by the ECB to the tune of 54 gigaeuros?

How long is that charity coalition going to hold together once they see others collecting on their CDS policies?

My guess is that something more than 10% those Greek bonds are held by entities which, in reality, are for-profit corporations with shareholders that know how to do a little arm-twisting of their own.

If you're a huge national pension fund that holds both Greek debt AND, say, a lot more Spanish debt, it's in your interest to exchange (and prevent contagion) even if other holders are making out better by not exchanging. If everyone refuses to exchange, Greece defaults and you could see contagion that impacts the rest of your portfolio. Most major holders have probably already written down the value of any Greek bonds anyway.

I believe that's true of the large private banks also, which is part of why this group amounting to 90% is on board. It's in the rational self-interest of a bank like Deutsche Bank or Societe Generale to take a haircut on their Greek-debt portfolio if it keeps the rest of their EU bond portfolio from blowing up--- especially if they can get a deal like this one where the EU governments partially reimburse the haircut.

OK, but what if you were using these Greek notes as collateral? Suddenly they're downgraded and you on the phone with your lenders. Are your lenders on board with this plan? They have reporting requirements too, it seems like you might be under an obligation to invoke your CDS policy if at all possible.

After all, why would the world spend $B on CDSs and then not invoke them when it came down to it?

Unless the notes were a large portion of your portfolio, it's not a problem. Given the relative size of Greece to the rest of the EU, unless you were running the "Greek Debt Investment Fund" you're still probably better off helping to prevent contagion and your lenders are too.

But... If I'm a hedge fund, why even own Greek debt plus the insurance? Just buy the insurance, and burn Greece. I'd also be buying (CDS) on other tipping-point countries, and watching the knock-on effect.

Ah : But that demonstrates how terrible CDS is, and how amoral hedge funds are. Actually (IMHO) the fact that Greek CDS was so cheap to buy was just an indication of how little trust people have that politicians respect the law in European countries. It would have been far cheaper to have sorted through this mess on day one, rather than spending taxpayer funds giving Greeks a lifeline when the changes that they have to make were always inevitable.

And now the politicians words have been demonstrated to be completely worthless, there'll be a lot more pain - in countries where it might otherwise have been unnecessary.

But... If I'm a hedge fund, why even own Greek debt plus the insurance?

CDSes are generally used to hedge a position. If a hedge fund holds both Greek bonds and CDSes on those bonds, they come out ahead regardless of what happens to Greece.

Only if buying the insurance was cheaper than the carry from owning the bonds. There's no reason that this should be a 'free lunch'. Indeed, CDS, the bonds, and the market for short-selling the bonds, form a no-arbitrage kind of thing : So that no one makes money without risk.

Why is buying unhedged CDS an amoral act? Is shorting a stock amoral? You shouldn't have to own a security to buy the default insurance on it, any more than you should have to buy a stock to own puts on it. It's a contract between two educated and willing counterparties.

A bank might be short Greek debt because of other trading positions, and want to sell Greek CDS to balance that position. Restricting who can buy that security hinders it being priced right.

I actually stated the opposite : People might use this as an example of how amoral hedgefunds are, but it turns out that they are just more clearsighted. Ditto shorting, HFT, etc.

what constitutes default will be pretty clearly defined in the contract - which is more in terms of credit "events" rather than just default. See for example the ISDA definitions: http://credit-deriv.com/isdadefinitions.htm

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