Why has the Greek default failed to spark panic?

Birds fly over a ruin in Greece
Image caption Investors fear there may be more trouble ahead for Greece

Late on Friday night the International Swaps and Derivatives Association (ISDA) declared Greece's latest deal with its private lenders to be a "credit event".

Rather than simply relying on a voluntary deal to cut the amount it owed to private lenders it had exercised a '"Collective Action Clause" to force those who had not signed up to its offer to take part.

To most onlookers this meant Greece had officially defaulted on its debts.


Yet international markets have, so far, barely reacted.

For more than a year journalists, politicians and bankers had warned the consequences of default would be dire.

In the summer last year, the former head of the European Central Bank (ECB), Jean-Claude Trichet said governments should "avoid whatever would trigger a credit event" for fear of spreading credit crunch-style contagion throughout the financial system.

But why the concern? Greece's lenders had already agreed in principle to write off some 107bn euros ($141bn, £89.9bn) worth of Greek debt voluntarily - what was the problem with it being officially a default?


Legally a default is different to a voluntary deal - however much pressure banks may have been under to agree the latter.

If banks decide "voluntarily" to write off the money they are owed, they cannot claim any money.

If, however, they are forced into accepting losses, then billions of euros of financial contracts - called Credit Default Swaps (CDSs) are activated, which can play a role similar to insurance.

The deal takes the form of a contract, usually between two financial institutions, where, in exchange for a fee one side agrees to pay the other if a country or company defaults on its debts.

In a quirk of financial engineering it is possible to take out this type of contract, even if you haven't actually borrowed any money.


That means its possible for there to be vast sums of money at stake even if the amount of money written off is relatively small.

Image caption Greece has struggled to stay within the euro

And with nobody knowing exactly who owes money to whom, if one big issuer of contracts goes bust, defaults can ripple through the system.

It's that prospect that scared European policy makers.

After all, contracts against defaults on sub-prime loans in the US had already brought down one of the world's largest companies, AIG, and imposed losses on countless others.

But it seems, the situation now has little in common with what happened then.

The amount owed by issuers isn't yet known, that will be decided by an auction of Greek bonds - a form of IOU - on Monday designed to set the price and establish everyone's losses.

The lower the price, the more money lost, the more is owed by the insurer.

But even if Greek bonds are virtually worthless the total amount to be paid out is far lower.

"AIG was at the centre of the US system at the time, Greece is not at the centre of the financial system and the part of Greek debt that is protected is smaller," says Giles Moec from Deutsche Bank.

Limited losses

In addition much of the Greek debt is now owned by bodies, such as the European Central Bank (ECB) which are unlikely to have taken out a CDS.

And the practice of taking out a CDS on a debt you don't have has been made illegal within Europe

Perhaps because of this the amount of contracts have fallen.

According to figures from the Depository Trust and Clearing Organisation, banks and financial institutions now have about $68.9bn worth of contracts on a Greek default.

It may sound a great deal - and it is - but it's much less than the total amount of debt being written off.

And to limit their losses banks have bet both ways with each other meaning they both win - and lose from a default, assuming nobody in the chain goes bust.

Their net position, the total profit and losses when everything is accounted for, is reported to be far smaller at $3.1bn.

What's more because most people assumed Greece would default, banks have already put aside much of the money they need to pay the insurance, something AIG failed to do.


All of this means, according to some market watchers, nobody is likely to be very inconvenienced by Greece's "official" default.

"To me, its been a bit overplayed," said Tom Lasarte from Merrill Lynch Bank of America.

In fact, for some, it's good news - it shows you can insure yourself against losing money on loans to European governments (and others).

"Its shown that the product works, people have faith that the CDS will help them, if they've managed to do a run around on CDS and not trigger it other sovereigns might find hard to sell debt, because you wouldn't be able to insure it," said David Geen, ISDA's general counsel.

But not everyone shares his benign view.

"The bigger concern is that all we've done is kick the can down the street a bit more," said Andrew Smith from Deloitte.

"Everybody suspects that in a few months time they'll come back and say can we have a bit more."

He adds that the figures we have for how much money banks have at risk on Monday are hard to verify, and there may yet be hidden surprises.

And if there are no problems it's partly because Greece is a relatively small economy, the insurance on Spanish or Italian debt may be a far larger issue.

Not to mention the impact the country's bankruptcy has so far had on its population, who don't benefit from any kind of sovereign insurance.

Greece's "benign" default then should probably not be a sign that others can follow suit.