1st Feb - Why not to call default a default?

Why not to call default a default

Leaders are afraid of the voters, not the market 

Why are the eurocrats so scared of calling the Greek default a default? There are some economic reasons for that, but mostly it is political. An involuntary event would trigger CDS contracts and make it official that an Euro member has defaulted. Many current systems from Basel Accord to central bank collateral policies would look idiotic. 

ECB as a sovereign backstop (i.e. accepting basically any useless promissory notes as valid collateral) would become politically more difficult to maintain. Voters who do not understand any of this, but still calling all the shots, could turn against their leaders and vote for parties promising more jobs, regulation and bank taxes and less China, EU and credit default swaps.

Countries with an unsustainable debt situation, notably Portugal and Spain, could start thinking that if the Greeks are allowed to do it, why not us as well? The official EU line and thinking is that the calling the Greek default a default and not something else would make markets nervous and spread the disease. The markets are already nervous - the default would not change anything on that front. It is the sovereign governments and their voters that the eurocrats are afraid of.

ECB is scared of being challenged

The ECB’s legacy policy from Trichet is “no defaults”. He lived through the 1992 series of everyone leaving ERM with pressure moving from one country to another. Trichet believes that letting the first one go would push everyone else on the same path. This is why the eurocrats try their hardest to repeat that Greece is a special case.

A more sinister motive is that Greece’s debt will not become sustainable without a haircut on ECB’s Greek bonds, acquired through the Securities Markets Program. While the purchases were done in the secondary markets at a relatively nice discount, it currently insists not participating in haircuts and retaining the nominal value (i.e. making a trading profit on its position).

ECB getting a haircut would set a nasty precedent, as there will sooner or later be other defaults. ECB’s SMP is loaded with Italian, Spanish and Portuguese bonds, and its paid-in capital is hardly enough to cover the possible losses from one default. ECB is facing the possibility of future deep losses and thus being forced to ask for a capital injection from the constituent central banks of the euro area.

It is politically much easier for ECB to let the banks take a hit, then recapitalize the banks with sovereign money either directly or via the ‘Death Stars’ (EFSF, ESM, Chewbacca). This would make ECB look like a reluctant savior, instead of being one that has to be saved.

The ECB is basically the only institution in Europe. Everything else is just plans, promises, lies and fancy titles. The ECB is not only the only backstop of defunct member states – it is the last stand of the euro project, and thus the European Union. The oblivion is getting uncomfortably close to the eurocrats.