Why Greece Is Not Lehman

The Greek debt crisis has been dominating the headlines again, as the Euro Zone came to an agreement on the second Greek bailout deal earlier this week. As a part of this deal, Greece will perform a debt swap and the current debt holders are expected to accept a 53.5% haircut on the bonds they are currently holding. According to the latest details, the newly instrumented bonds with a nominal value of less than half of the existing bonds would mature in 2042. Based on the reports, Greece would need 95% of the debt holders to agree with this arrangement, which might jeopardize the deal, as more than 5% of the bondholders may reject the deal. This raises the question about the Greek credit default swap, as an involuntary restructuring could trigger the CDS's. Some fear that this could lead to an AIG AIG type of event that would crumble the European financial markets, but the situation is not necessarily that serious. The key difference is that last fall the European Union banned naked CDS's to become permanent. Thus, the net amount of the credit default swaps that would get triggered is limited and much smaller than it was in 2008. Ben May, a macro analyst at London-based Capital Economics notes that there are approximately EUR 80 billion worth of the Greek CDS contracts and most of them are held by entities that are also holding the Greek bonds. The net amount is of these credit default swaps is approximately 3 billion Euros, May continued. As a comparison, AIG held $440 billion of credit default swaps when it was bailed out. Thus, it is evident that if the Greek CDS's get triggered the magnitude of turmoil would not be anywhere near what it was in 2008. However, if the credit event brings the Euro Zone fears to news highs, other troubled countries, such as Italy might see their borrowing costs skyrocket. If this was the case, Italy could be forced to default on its debt, which would trigger credit default swaps worth $314 billion. Traders should keep their eyes on the European financial stocks that could be affected by any CDS-related developments. Especially, the Dutch insurers ING ING and AEGON AEG could become very volatile, but also some of the U.S. banks, such as Goldman Sachs GS and Morgan Stanley MS could move on the news related to the Greek and Italian credit default swaps. You can follow me on Twitter @TuomoKallio.