Greek Bondholders Won't Be Paid, For Now

An international trade association ruled Thursday that the restructuring of Greece's government debt is not yet a "credit event." It means, for now, that Greek bondholders who took out billions of dollars of insurance contracts against Greece defaulting on its debt won't be paid. Robert Siegel talks with Scheherazade Rehman, Director of the European Union Research Center at The George Washington University.

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It's ALL THINGS CONSIDERED from NPR News. I'm Audie Cornish.

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And I'm Robert Siegel.

Many of us who'd never heard of credit default swaps learned about them when the mortgage crisis was upon us. An investor who bought a security that consisted of a bundle of risky mortgages hedged that bet by buying a credit default swap; in effect, insurance against a default. There are also credit defaults swaps on sovereign debts, bonds that countries issues. But for the insurance executive, someone must officially declare that a default has occurred, or a credit event, to use a term of art, has occurred.

So here's the question of the week. When Europe negotiated what's called a haircut for investors who hold Greek bonds, Greece would have to pay back only 45 and a half percent of what it owes, is that a fault a default or is that a credit event? Well, the official answer yesterday was no.

And to find out who gave that answer and what it may mean for the future, we're going to ask Scheherazade Rehman. She's a professor of international finance, business and international affairs at the George Washington University.

Welcome to the program.

PROFESSOR SCHEHERAZADE REHMAN: Thank you.

SIEGEL: Why can't a Greek bondholder call up the bank or the insurance companies that agree to that credit default swap and say, 46 and a half euros is not 100 euros, pay up?

REHMAN: Well, you know, you're right, but there is a body out there called the International Swaps and Derivatives Association, which is an association for the industry that determines whether a credit event has occurred or not. If they had determined in this case with the Greeks that a credit event had occurred, it would've triggered a payout of $3.25 billion in credit default swaps. But they determined at this stage that it was too early to say this was a credit event.

SIEGEL: But let me try to understand this from the standpoint from people who actually hold Greek bonds, or hold the bonds of other countries whose books don't look too great. Isn't the signal here that if the country that borrowed can organize an orderly agreement to not pay all of its debts, in full, on time, then you may be out of luck?

REHMAN: Well, you know, that's absolutely true. But the key word there is orderly and voluntary. As long as this is a voluntary exercise you can't really trigger a credit event.

SIEGEL: The other day, Christine Lagarde, that of the International Monetary Fund, said that what happens in Greece is really an outlying situation. It's different. Their situation is extreme. Does this have any relevance at all, though, for other countries and for the bonds of other countries?

REHMAN: Absolutely. You know, the Greece itself is, as you well know, a very small equation here. The problem is that if the Greeks defaults and there is a run on the Greek banks, there's no telling of the spillover effects into Spain and then eventually into Italy. And really, Italy is the 800-pound gorilla that everyone is worried about and wants to keep safe. So, therefore, in order to make sure nothing happens to Italy, we're trying to deal with the Greek situation as quickly and quietly as possible.

SIEGEL: Because there are huge, huge amounts of Italian bonds out there, this would be a lot more than $3 billion and some change.

REHMAN: Oh, Absolutely. In fact, that country is literally too big to save.

SIEGEL: You know, while very few of us are so well-heeled that we have insurance on our debts, we have insurance on our cars, we have insurance on our homes. Usually when you take out the insurance and it says you'll get it covered if somebody smashes into your car, you expect the insurer to say, yeah, there's the money - that's your policy.

REHMAN: Yes, you're right. This is like having a flood, and a very large one, and the insurance company fighting over the definition of a flood.

SIEGEL: Well, Professor Rehman, thank you very much for explaining that to us.

REHMAN: Thank you.

SIEGEL: Professor Scheherazade Rahman is the director of the E.U. Research Center at the George Washington University in Washington, D.C.

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