Greece is defaulting – don’t pretend otherwise



Suppose that I buy insurance against my house being burned down, and my house burns down. Should the insurance pay out? Maybe yes, maybe no. The simplest “no” case would be if I had volunteered to have my house burned down – say, had asked the arsonist to burn it. So if I purchase house insurance, there must be some provision that the insurance company doesn’t pay if the thing insured against was voluntary. Otherwise the insurance policyholder could arrange to have the insurance trigger, and engage in side-payments to bring that triggering about.

Similarly, if I insure against someone defaulting on a loan she has made to me, and she doesn’t pay, it is reasonable for the insurance company to have some provision to test whether her not paying was something I had wanted to happen. One condition under which someone might not pay could be if her debt to me were swapped for something better. So, for example, suppose I lent her £100 and she promised to pay back £110 in one year’s time, but then after eleven months she asked to swap that debt for an obligation to pay me £200 two month’s later. If my reason for accepting this deal were that I thought it better to be promised £200 in two months rather than £110 in one month, it would be inappropriate for the insurance on the £110 to pay out. Otherwise the borrower and lender could conspire to arrange the swap, extracting money from the insurer.

But suppose I were kidnapped by a pair of arsonists, and one poured petrol over my floors whilst the other drew a gun and pointed it at my head and said “If you don’t say the phrase “Burn it!” I’m going to shoot you.” Then I say “Burn it” and the arsonist proceeds. Would it be reasonable for the insurance company to refuse to pay out on the grounds that I had instructed the arson? Would it be correct to describe my house having been burned down as something I had “volunteered” to have happen?

Blatantly not. Similarly, if you owed me £110 in one month’s time and you said, “You can either agree to swap your £110 in on month for £10 now and £20 in two month’s time, or I’m paying you nothing at all” and I agreed, that wouldn’t mean there hadn’t been a default on the loan. It wouldn’t make the swap voluntary in the sense of the £200-for-£110 swap discussed above. It wouldn’t be that you were agreeing to the swap because you benefited from it. It would be a default.

I am repeatedly asked in television and radio interviews whether Greece will some day default – perhaps default even if the current negotiations succeed. But the Greek government plans to default. The negotiations are not about whether it will default, but only about how. It plans to impose a haircut on its private sector debtors of 50%-70% (depending on the coupon eventually agreed). That is defaulting. People say: “But isn’t the deal voluntary?” It’s only voluntary in the same sense that the kidnapped man with gun to his head “volunteers” to say “Burn it”. He could volunteer to be shot, just as the Greek bondholders could volunteer to have even larger haircuts imposed on them. But that doesn’t mean it’s not a default.

That is, of course, why S&P today, and other ratings agencies previously, have said that they regard the Greek “PSI” (“private sector involvement”) deal under negotiation as constituting a “selective default” – i.e. that the Greek authorities will be in default of some of their obligations.

The Greeks are defaulting. The probability of that is 100%. What is less certain is whether the agency that determines whether insurance contracts on Greek government debt (sovereign CDS) pay out – the International Swaps and Derivatives Association (ISDA) – will deem it to be a default in the technical sense required to trigger CDS contracts. Obviously they should be triggered, but whether they will be is another matter. But whether they are triggered or not, Greece is defaulting, and interviewers and journalists do nobody any favours by pretending otherwise.