I’m not going to quote this article, because it’s mostly pretty dry - but if you’re interested in the future of government borrowing, you should definitely read it.
Basically the problem is this: if the Greek government negotiates a deal with 90% of its creditors to hugely cut the amount of money it owes, does that count as a default? Because strictly speaking it wouldn’t be a voluntary negotiation for that last 10% of creditors, but if those 10% aren’t negotiating in good faith then is that acceptable?
It matters if this is technically a default because of credit default swaps, which are effectively insurance against default. Investors who buy Greek government bonds obviously would prefer to also have CDSs, because if the Greek government defaults then the CDSs would pay out. However, if it’s a voluntary negotiation, then that’s not a default, so the CDSs don’t pay out. (This is almost certainly why that last 10% of investors - mostly hedge funds - are holding out. They would rather get the CDS payouts than any possible deal.)
Note that either outcome has significant negative long-term ramifications. If the CDSs do pay out after renegotiation, then that’s a sign to investors that holding out and refusing to negotiate is profitable. If the CDSs don’t pay out under renegotiation, then that’s a sign that they’re not a trustworthy way to shield your investment, so no one will lend to risky governments anymore. Both are bad news for heavily indebted governments; it’s not clear which is less bad.
Paying out the CDS (a true default) fucks taxpayers because it will trigger a huge bilaterally net between banking institutions and then taxpayers plug the hole. NOT paying the CDS will wreck credit markets because primary dealers will have no instrument to hedge with. But nations can buy their own debt, and then the YTM pays out to the Treasuries from the central banks instead of out to bankers.
But the primary dealers won’t sell, because they’ve rehypothecated their sovereign holdings extensively and can’t afford to cash out their sovvie collateral. So why not just say “fuck your hedges, you’re implicitly nationalized anyway”?
