Last year, the US court sentenced the Cristina Kirchner government to pay their due to the bondholders who didn’t accept a 70 percent haircut of restructuring offers made in 2005 and 2010. That would be $1.33 billion. Now, the court has allowed the Argentinian Treasury to suggest a new agreement by next March 29, which some observers have eyed as a new chapter in international arbitration. But markets are showing little patience.

Argentina has so far led investors to believe that it is ready to default if necessary. That reaction, although less than surprising, would worsen further the lack of credibility of the Argentinian authorities. It looks like a no-win situation for everybody involved.

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“I can answer saying that the SMP was a monetary policy instrument. So the purchases of Greek bonds done under that program responded to public interest policy –general policy considerations. And as such, they deserve protection. This is one reason. The other reason is that I think the balance sheet of the ECB should be protected, because only through the integrity of the balance sheet of the ECB you can have the ECB independence in pursuing price stability in the whole of the euro area, and price stability is in the interest of all the members. So I think that’s one other reason why this exchange of bonds was quite right to do.

“But there is a third reason, I think, that people rarely think about this. I mean, we forget that this money is taxpayers’ money. And so the ECB has, in a sense, the duty to do everything to protect the taxpayers’ money that was entrusted with it. So this exchange of bonds was actually the right thing to do from this point of view as well.”

All of which, as the bondvigilantes blog points out, means he stated these three reasons: as this was done in order to promote public interests via the purchase of these securities, no losses should be incurred. The ECB needs to be protected, and can not suffer losses as this would damage its reputation and its balance sheet. And the ECB is acting on behalf of tax payers, and tax payers should not take losses.

Therefore, private bondholders are not taxpayers and do not deserve being able to avoid losses, do not deserve a legal shield.

Now, the truth is that the ECB is not Greece’s central bank, or Spain’s, nor anybody else’s for that matter. A central bank is an entity member of a state that appoints it to issue sovereign debt, and which doesn’t suffer losses when those bonds fall on the markets because it doesn’t have to sell them to survive. These losses are accounting records but have no consequences over assets.

On the contrary, the ECB is a new central bank, apparently so pure that can never get its hands dirty. It is true that Greece has defaulted, but we all knew it would and should never have come in the euro zone. It is not alone, in that. For the moment Greece doesn’t leave the euro zone, its holes are more or less being covered and that is all.

Yet, who will dare to purchase Greek bonds or invest in Greece knowing that, come default, private investors will pay for all broken commitments?

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“The indications we have are that the debt swap seems to be going well. Greece will get the necessary bailout as we have now cleared the major hurdle and can look forward to a new beginning,” Papadopoulos explained, although he also acknowledged that “we are buying time in order to make changes that should have been made in the last 30 years.”

Greece’s government assured minutes afterwards that approximately 85pc of its creditors had accepted an accord to exchange their bond holdings to new securities, with private investors accepting a face-value loss of between 53.5pc of the initial sums of capital they had placed to up to a 75pc haircut.

That would mean that the country would effectively take more than €100bn off its public debt burden. The biggest restructuring in history, as described by Bloomberg, is today among us.

What next, now? There still hangs the question of convincing the rest of bondholders, many of which are hedge funds and have so far refused to share any measure of pain in the Greek state finances crumbling down to the floor. Greece’s government could force them to follow suit by activating special clausules but the International Swaps and Derivatives Association has ruled the swap will not be considered a default only if it is voluntary. Otherwise, the deal would in the end trigger the type of credit event that involves sellers of Credit Default Swaps on those Greek sovereign bonds to pay out to buyers of these products, who purchased them as a way of hedging risk.

If CDS were to step into the Greek scenario, billion of euros more would be charged to the total bill. Some analysts said this was the only recourse the government had to complete the deal. Here is a biased exposition of a biased CDS market:

“A special committee that governs credit-default swaps got together and said: the Greek bailout —a write down of 50 percent of the value of Greek debt— is voluntary and thus does not trigger the contractual terms of credit-default swaps. That means the companies that sold the CDSes will not have to cover the losses they had insured, that is, the decline in value of the Greek bonds. Who votes on this committee?  This will shock you: the very banks that issue, and often purchase, the CDSes at issue: Goldman, JPMorgan Chase, Citibank, UBS.

“No government entity at all. Just the same players who have an enormous interest in whether or not the CDS obligations are enforced.  And this special committee votes in secret, with no public accountability.”

Indeed, the CDS is blamed by some as an original sin of the financial markets at their murkiest and wildest:

“The Commodity Futures Modernization Act radically deregulated derivatives. The law changed the Commodity Exchange Act of 1936 (CEA) to exempt derivatives transactions from regulations as either futures (under the CEA) or securities under federal securities laws. Further, the CFMA specifically exempted Credit Defaults Swaps and other derivative products from regulation by any State Insurance Board or Regulators.

“This rule change exempting CDS from insurance oversight led to a very specific economic behavioral change: Companies that wrote insurance had to explicitly reserve for expected losses and eventual payout in a conservative manner. Companies that wrote Credit Defaults Swaps did not.”

Something to remember next time we hear that insurance on bonds of [write the name of a European Monetary Union country member] has spiked and the common currency is breathing with difficulty, close to its collapse…

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Brussels may begin proceedings for an excessive deficit record, send troikas and missions to instruct those who do not respect the rules, threaten them with sanctions … but it’s much ado about nothing. The real trouble comes when the credit markets shut down.

Default risk is embedded in the market, in those who finance borrowers with the expectation of recovering their money. The biggest the risk of default, the more expensive the credit gets; and when there is little safety, no money will be paid. Deficit issues result in risk premium and are measured with a differential regarding the best payer. And when the differential grows, problems worsen and consequences are severe.

A 5.8% deficit (1.4 points up from what was agreed) proposed by Rajoy’s government this year may seem reasonable, credible, and even ambitious for some, taking the last facts and trends into account. After all, the Spanish government would reduce 2011 deficit in 2.7 points, leaving it half of what is was in 2009. But it remains a spectacular figure, that only strong economies such as the Japanese, the American and the British can afford. For a second-tier economy as the Spanish, that deficit figure is dangerous.

Rajoy is aware of that. Therefore, he argues, meeting the 3% target by 2013 and the reforms his government has approved, are the best guarantors of his clear goals and commitment to achieve them. He can nail it.  But he can also fall short and waste the trust polls show he got after his reforms.

Yet, the daily survey is called debt risk premium. So far so good, much more than expected is being issued and at a good price. ECB credit facilities have been decisive, but the key factor is the country’s and policies’ credibility. For months Italy has served as a protective shield for Spanish debt, its spread was higher. But the new Italian government of Mr. Monti is earning credit and authority every week and equates its differential with the Spanish.

Staying behind in this race is not recommended. That is the risk of the Spanish government bet: being compared to Italy, whose budget deficit is around 4% (and 9% of unemployment rate). Italy’s debt per GDP doubles the Spanish one and the country is experiencing a more severe recessions. Their strengths are also bigger, though.

This is a long-distance race, with many obstacles and changing requirements. What is unaffordable today might be inevitable tomorrow. But the key still is whether credit is or not open.

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CDS are a US$32 trillion market, which is more than twice the US gross domestic product and more than twice the national debt. They are financial instruments meant to protect against a default by a particular bond or security, invented by Wall Street in the late 1990s as a form of insurance. It is an unregulated market (there is no requirement that the “insurer” actually have the funds to pay up) and some call it a derivative scheme.

The European Union considers CDS positions can increase risk of financial stability. CDS trading have been blamed for aggravating Greece’s troubles. The EU is in the process of approving a new regulation to ban on naked CDS trading, that is, purchasing default insurance contracts without owning the related bonds. It should be in force in November 2012.

“Purchasing Italian CDS, for example, will now be possible only if the buyer already owns Italian government bonds or a stake in a sector highly dependent on the performance of these bonds, such as an Italian bank,” explains New Europe newspaper.

THE BIG FIVE ARE WORRIED

According to the Comptroller of the Currency, nearly 95 percent of the banking industry’s total exposure to derivatives contracts is held by the nation’s five largest banks: JPMorgan Chase, Citigroup, Bank of America, HSBC, and Goldman Sachs. 

Now the Big Five fear that a “credit event” declared on European sovereign debt could jeopardize their $32 trillion market. William Greider writes about the ‘bank lobbyists’ at The Nation:

“Financial market cynics have assumed all along that Dodd-Frank did not end ‘too big to fail’ but instead created a charmed circle of protected banks labelled ‘systemically important’ that will not be allowed to fail, no matter how badly they behave,” he says.

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