After a Deal, Only More Challenges

This article is by Louise Story, Eric Dash and Julie Creswell

Tourists at the airport in Heraklion, Crete, where taxis are striking to protest austerity measures imposed as part of the debt crisis.

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. 
It is unclear how long it will take for the agencies to react. Moody Investor Services pointed out in a statement that it was “not a party to ongoing discussions on the Greek debt rollover,” and that it was observing developments and rating implications “in due course.” A spokesperson for Fitch Ratings said there were no changes to Greece’s ratings at that point. Standard & Poor’s declined to comment.

Because ratings agencies did not provide much information just after the plan was announced, investors will be awaiting a decision on Friday.
“They’ve told us in the past that any sort of debt restructuring, such as a significant maturity extension, would be considered a default. Here we’re exchanging short-term debt for 30-year debt,” said Jerry Webman, the chief economist at Oppenheimer Funds. “Obviously one of the sticking points has been to try to get a lot of the technicalities right so that you don’t get a default rating.”
 Apart from the ratings agencies, another default ruling will likely come over the next few days from the International Swaps and Derivatives Association. After a well-known market participant requests that the industry association determine whether a default has occurred, a committee of 10 banks and five large asset managers will convene by telephone to opine on the matter. Their decision matters because it will drive large profits and losses for investors, depending on whether they bet for or against Greece, and some analysts have expressed fears that there may be a company that has a concentrated position that it may have trouble paying off.
The committee has never before had to consider a selective default and so traders will watch their voting with interest. The results and votes cast by each firm on the committee will be made public, said Steve Kennedy, a spokesman for ISDA.
Mr. Kennedy said he believed that the derivatives market would sort the matter out “calmly and according to the process that’s been established.”
Closer to home for most Americans are money market funds, which hold billions in European banks’ debt, though analysts said the funds should remain safe under the plan. This summer, some estimates said 50 percent of the $1.6 trillion in prime money market fund assets were in the debt of European banks.
Many money markets have been decreasing their exposure to Europe. About a year ago managers overseeing the $110 billion Vanguard Prime Money Market Fund, for instance, decided to reduce the fund’s holdings of banks in different countries that had a larger exposure to Greece and other countries in the periphery.
“Money-market funds are at least three steps removed from any Greek debt. Greece would have to take down Spain or Italy in order to become a threat to the French banks which money funds hold the debt of,” said Peter Crane, president of Crane Data, which tracks such funds.