Playing “Chicken” in Greece

The Great Bond Swap is underway for holders of Greek debt. In this exercise, Greek bondholders “volunteer” to let Greece default on the bonds they own now in exchange for fewer new bonds structured with lower interest rates and longer maturities. To be effective, over 90% of the holders of Greek debt need to agree to take a beating. At that level of participation, The Great Bond Swap can be called an “orderly default” wherein life as we know it is not supposed to change much, as opposed to a “disorderly default” wherein all hell breaks loose. To be sure, we don’t quite quite understand the nuance. A default is a default. Furthermore, everyone is Greek-fatigued, and has likely accommodated the idea of default over the last two years, so we suspect even a disorderly default won’t have a lasting (a key word!) impact at this stage of the game.

In any event, the Bond Swap agreement is meticulous and complicated, but the general idea is to inflict pain on those who do not participate. Bond holders, of course, are eyeing each other to see what the next guy is going to do or whether they can all stonewall the process to garner better terms. From that perspective it is an interesting economic event for econo-geeks like us, but probably boring for anyone who is normal. But there’s one hole in the Swap agreement that is worth pointing out: many of the holders of Greek debt also bought insurance against default for the debt. These are called credit default swaps, and they pay if Greece defaults. But under the contract, the CDS’s only pay if the default is not voluntary! These people have no incentive to play ball. In fact, they will probably gain more if there is a disorderly, “involuntary” default because their bonds might become worthless but the insurance they bought will pay them back, and more than the Greeks are willing to offer under the terms of the Bond Swap.

Witching hour is this Thursday, roughly 3 pm Eastern time. That’s when the terms of the swap expire. If there’s a shortfall in the number of participants, look out for a rough time in the markets as everyone adjusts to the uncertainty. Unfortunately, there’s no countdown clock tabulating the number of participants who have signed up, so we’ll just have to wait for the news tomorrow.