The talking is over; it is finally happening. For the first time since World War Two, a developed nation is going into default.
That’s the significance of the events of the past 24 hours, with Greece’s debt being classified as in “selective default” and the European Central Bank banning it from its cash window. Months of planning by both banks and policymakers have gone into ensuring that Greece’s negotiated default will be a smooth painless process. We are about to find out whether that planning pays off.
Now, we shouldn’t be surprised by Standard & Poor’s decision to cut the rating on Greece’s sovereign debt from CC to SD (which stands for “selective default”). The ratings agencies had always said that, given private investors are about to lose just over half the value of their debt (through a complex bond swap), this downgrade would be a natural consequence.
Nor should we be shocked that the ECB says it will no longer accept Greek debt as collateral: in fact, the only surprise is that it’s taken this long – on the basis of the ECB’s previous policy, the bonds should have become ineligible when were first downgraded from investment status two years ago.
Peter Tchir thinks all the hullabaloo is a lot of sound and fury, signifying nothing:
So far there are no dramatic consequences of the Greek default. The ECB did say they couldn’t accept it as collateral, but national central banks (including Greece’s somehow solvent NCB) can, so no real change. We will likely get a Credit Event prior to March 20th once CAC’s are used to get the deal fully done. Will the market respond much to that? Probably not, though there is a higher risk of unforeseen consequences from that, than there was from the S&P downgrade.
It just strikes me that Europe wasted a year or more, and has created a less stable system than it had before. A year ago, Europe was adamant about no haircuts and no default. I could never understand why. Let Greece default, renegotiate terms, stay in the Euro and move on.
I suppose the magnitude of the problem depends on just which kind of credit event. And that mostly depends on how well-insulated the financial system is, and market psychology. A full-blown Lehmanesque credit shock? Who knows — certainly banks are fearful. Certainly, the problem of default cascades has been out in the open for a while. But most of the attempts to deal with the prospect of such things have mostly been emergency room treatment, and not preventative medicine — throwing liquidity at the problem. Certainly, it is possible the system is in a worse shape than 2008.
- The derivatives web is (nearly) as big as ever:
- There are still a myriad of European housing bubbles ready to pop.
- American banks are massively exposed to Europe.
- China’s housing bubble is bursting Surely their reserves will go into bailing out their own problems, and not those of Europe and America?
- Rising commodity prices — especially oil — are already squeezing consumers and producers with cost-push inflation.
Meanwhile, the only weapon central bankers have in their arsenal is throwing more money at the problem.
Will throwing more money at the problem work? Yes — in the short term. The danger is that creditor nations will not be prepared to throw enough to shore up balance sheets.
Will throwing money at the problems cause more problems in the long run? Yes — almost certainly.
Ultimately, we must look at preventative medicine — to stop credit bubbles expanding beyond the productive capacity of the economy. We should also look at insulating the economy from the breakdown of any credit bubbles that do form.