Investors Bet on Prospect of 'Greek Accident'

A new bet has been placed on the the Greek debt crisis. It backs a growing view among investors that Athens may be about to suffer a messy default that could spark a run on the country’s banks and a deeper euro zone crisis.


Tensions around Greece again mounted on Wednesday amid bickering among euro zone policymakers and reports that George Papandreou, the Greek prime minister, had threatened to resign.

This triggered steep rises in peripheral bond yields and credit default swaps, with some breaking fresh euro-era highs.

One senior investor said: “There is a meaningful chance of a Greek accident this summer. That involves a hard default and big losses for investors, which could have very worrying repercussions for the euro zone.”

These fears have prompted bets on the so-called “accident scenario”, which involves buying one-year credit default swaps that would pay out big profits in the event of a hard default, typically a non-payment of loans, in the next 12 months.

Although these funds have placed only a small amount of money on these bets, the mere fact that they are using them highlights the growing risks for the euro zone.

Indeed, many investors say that euro zone policymakers are running out of time, warning that decisions over Greece’s second bail-out must be made soon or sentiment will deteriorate further and lead to contagion and a graver crisis.

A failure by euro zone finance ministers to break the deadlock on how to involve private investors in a Greek bail-out at an emergency meeting in Brussels highlighted the loss of patience with policy-makers in the markets.

Along with worries over the future of the Greek government and protests against cuts on the streets of Athens, it unnerved investors.

Greek two-year bond yields, which have an inverse relationship with prices, lurched 160 basis points higher, one of the biggest daily moves of the year, to a euro-era record of 28.02 percent.

Greek five-year CDS leapt to a high of 1,700 basis points, or a cost of $1.7 million to insure $10 million of debt annually over five years. Greek CDS is also pricing a 75 percent chance of a default by the country over the next five years – it was about 45 percent at the start of the year.

Irish and Portuguese two-year yields and five-year CDS also jumped to record highs. More worryingly, Spanish and Italian bond markets were hit too, with Spanish bond yields closing in on highs last seen in 2000.

Critically, strategists and investors said that a signal on Wednesday by the International Monetary Fund that it will provide Greece with the next tranche of loans has eased worries over an imminent default.

Without these loans, Greece was in danger of defaulting on bonds due for repayment in July.

However, there is still pressure on Europe’s leaders to agree swiftly on a bail-out deal for Greece.

Ralf Preusser, head of European rates research at Bank of America Merrill Lynch, says: “It is essential that policymakers get their act together and come up with some sort of agreement at the European Union summit [on June 24]. “Otherwise, there is a danger that the debt crisis will deepen,” he added.

“I am sure the EU will come up with something to steady the markets because the alternative is too horrendous but the risks are there.” He thinks that the EU will agree to additional Greek loans of 50 billion euros at next week’s summit and announce a working group to discuss rolling over Athens’ debt with investors to ensure the country is fully funded for the next two years.

John Stopford, head of fixed income at Investec, agreed that Europe’s leaders will come up with some kind of solution to ensure that Greece can fund itself through to 2013, averting the threat of a default for the time being at least.

“My sense is that policy-makers will try to avoid a hard default at all costs,” he says.

“Every time push has come to shove, European policymakers have done just enough to avoid the disaster scenario.” Significantly, both Mr Preusser and Mr Stopford believe that a Greek rescue plan involving a debt roll-over may not trigger a selective default by rating agencies or a credit event in the credit default swaps market.

Both a selective default, which is a default on some but not all Greek bonds and loans, and a credit event, which is the trigger for a pay-out in the CDS market, could create big problems for euro zone banks.

The European Central Bank has warned that it will not accept Greek bonds as collateral for loans in the event of a selective default, which could push Athens’ financial system close to collapse, while a credit event could hurt the balance sheets of those banks liable for CDS pay-outs.

Many investors and strategists are sanguine about a Greek default but it is the risk of contagion that really worries them.

Mr Stopford says: “EU policymakers cannot let the debate over the Greek bail-out drag on because of the threat to Spain. The longer it drags on, the greater the risk of contagion. If Spain gets sucked into the crisis, then all bets are off.”

Arif Husain, director of European fixed income at AllianceBernstein, agrees: “Spain needs to fund itself through the market. We can’t afford to bail out Spain and we can’t afford to allow Spain to go into a death spiral.”