Reply #71: Why Not Pull the Trigger on Greek Default Swaps?

[Demeter]

BECAUSE THEN WE WILL SEE WHO IS SWIMMING NAKED?

http://dealbook.nytimes.com/2011/11/23/why-not-pull-the-trigger-on-greek-c-d-s/

The question about why credit-default swaps written on Greek debt will not be triggered by the “voluntary” exchange of private debt that is in the works has been the subject of much recent commentary but little deep analysis.

The basic question is, why not trigger the swaps? And why do some think that the swaps are not apt to be triggered if bondholders hold out and refuse to exchange?

In a corporate exchange offer, you would suspect that the exchange was being done with exit consents. These get the departing bondholders to agree to strip out all the possible default triggers (other than pure failure to pay), making it less likely that a swap would be triggered going forward. But with sovereign debt, such bonds are not apt to have many of those covenants anyway.

The really important issue here centers on why the European Union cares so much about not setting off credit-default swap triggers in this exchange offer. The absurd lengths European leaders are going to in order to make this “voluntary” does raise a few eyebrows. And I have no really compelling explanations. Still, would it be so hard to imagine that the Eurpean Union wants to avoid setting off the swaps because of aggregate exposure among European banks to Greek and other European sovereign debt? For example, what if European banks have all been hedging their sovereign credit-default swaps with each other. If that proves to be the case, a German bank with seemingly modest net exposure to sovereign debts, for example, could really be heavily exposed because the hedge is with a French bank?

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Stephen J. Lubben is the Daniel J. Moore Professor of Law at Seton Hall Law School and an expert on bankruptcy.