By Dave Kansas MAY 24, 2011, 11:59 AM ET
Eurocrats insist that Greece will not default on its sovereign debt obligations, but the markets think otherwise.
As politicians and policy makers haggle, analysts are trying to game-out what would happen in the event Greece defaulted. Moody’s Investors Service in a note this morning tried to put a little meat on the default scenario, and it made for some pretty dark reading.
Let’s break it down, with a little Translation Time.
Moody’s: Moody’s Investors Service has explored possible Greek default scenarios in order to assess the impact on the country’s sovereign rating, the consequences for Greek banks and the possible paths of credit contagion to other European sovereigns, which are discussed in a Special Comment published today.
TT: Leading with “contagion” surely gets attention. If Greek defaults, it won’t be an Athens-only affair. Seatbelts, tighten ‘em.
Moody’s: Moody’s did not comment on the likelihood or the desirability of a debt restructuring, but focused more narrowly on some of the credit implications of different default scenarios.
TT: Moody’s has no dog in this fight. Just a passive observer. Right.
Moody’s: It is apparent that the longer the current state of uncertainty affecting Greece persists, the greater the temptation on the part of both the Greek and the euro area authorities to try to undertake some form of debt restructuring — in other words, to allow Greece to default. A Greek default might take many forms, including changes in terms and conditions, selective “re-profiling” and large-scale “voluntary” debt buybacks at high discounts, which Moody’s classifies as distressed exchanges.
TT: This is a killer graph. Moody’s is saying that linguistic gymnastics won’t cut it. Eurocrats can craft clever words, like “re-profiling,” but Moody’s will call it what it is: a default. And that’s bad.
Moody’s: Moody’s believes that a default is likely to have adverse credit rating implications for Greece, possibly some other stressed European sovereigns, and the Greek banks, regardless of the efforts made to achieve an “orderly” outcome. The full impact on Europe’s capital markets would be hard to predict and harder still to control. The fallout would have implications for the creditworthiness (and hence the ratings) of issuers across Europe.
TT: Whoa-kay. Even if a default is Tuetonically crisp and neat, it will probably create a mess in the markets. Obviously, Greece gets pummeled if it defaults. But it’s not just Greece – “other stressed European sovereigns” means Ireland and Portugal. Greek banks, which hold a lot of Greek debt, are an obvious target. But Moody’s also says all of Europe would face creditworthiness issues. The interconnectedness of the European banking system (not exactly brimming with health) with the sovereign debt challenges is lurking behind these opaque words. No wonder the ECB and EU are so fretful.
Moody’s: The impact on the Greek government’s creditworthiness itself would depend on the extent to which a default would — by lowering the face value of outstanding debt — improve the affordability of the country’s debt obligations. A default would most likely cause Greece’s rating to migrate down to Ca or C and remain in the Ca and Caa territory for a sustained period following a default, barring the unlikely event that the resulting debt reduction is so great that the risk of a second default becomes quite low.
TT: Intriguing. After warning of mayhem, and stating that Greece will get downgraded deeper into junk status, Moody’s kind of says that if the default puts Greece in a supremely good place, maybe things could work out, eventually. This is saying: If you go down the default path, no more half-measures. It has to be a big, massive thing that answers the Greek issue once-and-for-all. It would still be messy.
Moody’s: The Greek banking sector would require recapitalizing to offset banks’ losses on Greek government bonds, and continued liquidity support from the European Central Bank, at least for as long as the sovereign’s own access to the capital markets remained impaired. Should that support be forthcoming, then the Greek banks’ ratings could stay in the B range. A more likely scenario is that a sovereign default is accompanied by some form of default on bank debt, in which case banks would also experience multi-notch downgrades, quite possibly to as low as Greece’s own rating.
TT: More detail on the interconnectedness of Greek banks and Greek sovereign debt. So goes Greece, so go its banks (and other non-Greek banks who have fingers in the Greece pie). Don’t overlook the sentence about access to capital markets. The implication is that a default would leave Greece dependent on non-market funding (read: EU/IMF/ECB) for an extended period. Think Argentina.
Moody’s: As for other stressed European sovereigns, Moody’s believes that their ratings will invariably be affected, regardless of the myriad forms that a default by Greece could take. This would in turn lead to increasingly polarized sovereign ratings in Europe, with stronger countries retaining high or very high ratings, and weaker countries struggling to remain in investment grade.
TT: Reiterating that Portugal and Ireland will face immediate debt-rating risks. Left unsaid: What happens to Spain, Italy or Belgium, countries considered at risk, but not in the same league as Ireland, Portugal and Greece. That’s a rather large omission.
Moody’s: Since the bailout program for Greece was first announced in May 2010, the country’s default risk has continued to rise due to (1) weaker-than-expected economic growth, (2) underperformance against debt consolidation targets, (3) growing political protests in reaction to planned austerity measures, (4) declining market confidence and access, (5) as well as the increasingly mixed messages from Greece’s supporters. These developments contributed to Moody’s significant downward adjustments to Greece’s rating in 2010 and to its decision, earlier this month, to place Greece’s B1 debt rating on review (which is ongoing) for further possible downgrade.
TT: The May 2010 bailout hasn’t worked. And items 1, 2, 3 and 4 are all moving in the wrong direction. And there’s no prospect that will change. Item 5 — Eurocrats can’t get their story straight, and that muddle isn’t helping. The place is still a mess and we might downgrade again.
As High Frequency Economics says today: “Underlying problems of over-borrowed nations are not fixed by lending them more money.”
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