September 20, 2020

After a Deal, Only More Challenges

So far so good was the word on Wall Street Thursday as details emerged about Europe’s latest broad, sweeping effort to relieve Greece’s debt burden.

But, analysts said, it was unclear how the ambitious plan — which includes Greece changing the terms of its debt — would affect the markets in the coming days.

The conventional thinking had been that a Greek default would spur contagion in the financial markets, potentially roiling United States banks and mutual funds. But on Thursday, as details emerged of a plan that was characterized as a “selective default,” stocks on both sides of the Atlantic rose. The euro climbed to a two-week high against the dollar. And bonds in Spain, Greece and Italy ticked upward, while bets against Greece’s debt sunk.

What was behind the muted response, analysts said, was that Europe had avoided the trademarks of traditional sovereign defaults, which more typically involve bondholders and creditors taking sudden, definite losses. Greece’s problems are hardly a surprise, having been telegraphed for nearly a year and a half. And many of the losses connected to Greece’s debt, it turns out, will be shared by the euro zone and may not affect investors like United States money market funds as much as has been feared.

“This is the Europeanization of the Greek debt,” said Perry Mehrling, a senior fellow at the Morin Center for Banking and Financial Law at Boston University. “Everyone prefers to have Europe as their counterparty rather than Greece.”

But the markets may also be calm because it is simply not clear yet what all the repercussions of the deal will be. Many questions are left unanswered, including whether the credit ratings agencies will consider the deal a default or an action that should affect ratings across the Continent. And in the derivatives market — where traders have been swapping instruments that allow them to bet against Greek and other sovereign debt — it is unclear whether the industry association that makes rulings on those contracts will declare that the parties that bet against Greece should be paid, or not.

Also clouding the market is the question of whether Europe’s plan for Greece is more of a bailout or a default — selective default, the term being used to describe the plan, is a term few investors have ever heard before. The ratings agencies declined to discuss their thoughts on the deal after it was announced, but they have said in the past that measures similar to the ones announced, including extensions of the length of the debt, would qualify as a default. And Greece’s situation is an anomaly for derivatives traders, who are more used to settling up after defaults of corporations, rather than those of countries.

Details of Europe’s deal leaked out all day Thursday, but it was formally described in a four-page memorandum released in the evening. It has options including a bond swap that will relieve Greece’s bondholders — mostly banks in Greece, France and Germany — of short-term bonds in exchange for new longer-term bonds that will be guaranteed by the euro zone. It includes 109 billion euros ($157 billion) in aid to Greece. The memo says that a pan-European entity will make loans to individual countries so that those countries can work to recapitalize banks there that are hit by losses on the Greek debt.

Analysts said the deal resembled the federal bank bailout that occurred in the United States in 2008, because it included a way to aid institutions that were heavily stung by losses on Greece, much like the United States aided banks that were hard hit by mortgage bonds. Several analysts cheered simply because it was a sign of progress.

“The light at the end of tunnel just got a lot brighter,” said Chris Orndorff, a Western Asset portfolio manager who oversees more than $39 billion of European corporate and sovereign debt. “What they are really trying to do here is stop the contagion. It provides a degree of confidence to investors in Ireland, Portugal, Spain and Italy that it is not going to be a downward spiral.”

Others criticized European officials for trying to sugarcoat the plan. “I’m shocked they would use the term ‘selective default.’ Any adjective you put in front of the word default still means default,” said Zane Brown, fixed-income strategist at Lord Abbett.

Dogging all those countries are doubts over their credit ratings, which can drive the costs for them to borrow. To some degree, Europe’s backing of Greece may relieve some of the doubts that have driven the ratings agencies to issue warnings about several European countries — like Italy, Spain, Portugal, Ireland.

Article source: http://feeds.nytimes.com/click.phdo?i=50fe346672d4a922f458bf59bc513f34

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