Greek Default: Why Europe Thinks It May Not Be So Bad

European leaders are beginning to accept the idea that Greece will be forced to default on its debt, causing a long-feared "credit event" that triggers billions of dollars of credit default swaps.

Macduff Everton | Ironica | Getty Images

Financial markets have been worried for months about such an event, fearing that it would spark another financial crisis similar to the one that was triggered by the collapse of Lehman Brothers in 2008.

But European leaders are becoming less worried about the impact such an event would have on the global financial system. There are two reasons for this: an involuntary Greek default would not come as a surprise to financial markets, and the amount of money involved would be relatively small.

Back in September 2008, almost no one believed the government would allow Lehman to fail, and when it did, it took market participants by surprise. Greece on the other hand has been a train wreck in slow motion.

That’s significant, because as a default becomes increasingly likely, more and more credit default swaps—insurance politices that pay out if there's an involuntary Greek default—have to be collateralized.

The International Swaps and Derivatives Association says the total net exposure of market participants who have sold CDS credit protection on Greek sovereign debt was about $3.7 billion as of Oct. 21, 2011. At this point, the group estimates that more than 90 percent of Greek CDSs have been collateralized. In other words, most of the insurance has already been paid.

In a first-on CNBC interview on Tuesday, the lead negotiatior for private-sector Greek debt holders, Charles Dallara, raised the possibility of a credit event in the case of Greek debt.

"We remain committed to a voluntary accord," said Dallara, head of the Institute of International Finance. But "I am not entirely clear at this point all parties are committed to a voluntary accord and I hope that is not the case."

Talks have broken down with private Greek debt holders and Euro Zone finance ministers over how much of a "haircut"—or loss—the debt holders must take to restructure Greece's debt. Even if a "voluntary" deal is struck soon, not all bondholders may participate, which could trigger an "involuntary" default.

Standard & Poor's also signaled Tuesday that a Greek default may not be so calamitous.

The rating agency said it will likely downgrade Greece's ratings to "selective default" when the country concludes its debt restructuring, but that won't necessarily destroy the credibility of the European Union, an official with the ratings agency said on Tuesday.

"It's not a given that Greece's default would have a domino effect in the euro zone," John Chambers, the chairman of S&P's sovereign rating committee, said.