So, What Happens if Greece Can't Pay Up?

♠ Posted by Emmanuel in at 4/30/2010 12:01:00 AM
Here are three disaster scenarios I found from Reuters if Europeans cannot figure out how to stave off Greek capitulation. These are arranged in terms of increasing anarchy and improbability:


PROBABILITY: most likely in the medium to long term

Greece would negotiate a restructuring of its debt before missing a payment. This would require investors to take a significant discount on their debt holdings and could include extending maturities or possibly investors switching to longer maturities. Bondholders could, however, see haircuts of anything from 20 to 40 percent of the net asset value of their debt positions, according to some analysts' calculations.

According to Brown Brothers Harriman's calculations, the current two-year Greek/German bond yield spread is consistent with about a 25 percent chance of a 50 percent haircut or about a 33 percent chance of a 40 percent haircut. The two-year Greek/German bond yield spread has ballooned to more than 1,400 basis points as investors pummelled Greek debt.

MARKET IMPACT: Spreads on other highly-indebted countries in the euro zone would widen sharply while German benchmarks would benefit from flight to quality and the euro could fall to around $1.15, levels last seen in 2005.


PROBABILITY: highly unlikely

Greece could impose a debt restructuring on its creditors, for example extending maturities or forcing investors to take haircuts without prior agreement. Historically, non-negotiated restructuring are more likely to result in a haircut for creditors than are agreed restructurings.

An even more unlikely outcome under this scenario is that markets punish Greece so severely that, despite enormous legal and logistical obstacles, Athens would elect to leave the euro zone and European Union. However, market consensus is that leaving the currency union would make it even more costly for any fiscally weaker country to borrow because of the addition of an exchange risk premium to the sovereign risk premium.

MARKET IMPACT: The euro would be hit even harder as markets would as a knee-jerk reaction price in a greater risk of euro zone disintegration. Spreads of higher-yielding euro zone countries would blow out even further versus German benchmarks.


PROBABILITY: highly unlikely

About 70 percent of Greek debt is estimated to be held by foreigners, most of them within the euro zone, notably German and French financial institutions. European Union officials will try to avoid an outright default.

An outright default by Greece or any country facing a similar situation would mean exclusion from capital markets, as happened with Argentina when it defaulted in 2001. The South American country has not issued any euro or dollar-denominated debt since then as it has yet to come to an agreement with international creditors.

MARKET IMPACT: The euro would most likely fall below parity against the dollar, intra euro zone bond yield spreads would blow out, with the bond market for other countries facing fiscal challenges drying up, leaving only triple-A rated countries able to issue debt.


Other possibilities include the European Central Bank providing loans to help Greece meet its obligations, buying Greek bonds or relaxing its collateral rules yet further to accept any bonds as collateral irrespective of their ratings. However, such scenarios are seen as outliers as they would require political or policy decisions that analysts say would be very difficult to achieve.

Another complicating factor is that many investors have bet on a default through credit default swaps and thus have a vested interest in forcing such an outcome.