Hedge Funds Playing Chicken With Greek Debt

The political drama has long since moved on to Italy, but the details still haven’t been worked out over the question of Greek debt and hedge funds are a big part of the reason.

The issue, as you may recall, went like this. Greece was genuinely honest-to-God insolvent and couldn’t cover its debts. It needed to default. But European governments didn’t want Greece to default since a default would trigger a wave of credit default swap contracts. But Germany also didn’t want the banks that owned Greek debt to be fully bailed out. So Angela Merkel worked out a goofy scheme in which holders of Greek bonds—largely French and German banks—would voluntarily accept getting paid only 50 percent of what they were owed, with the voluntary nature of the agreement underscored by strong pressure from the French and German governments. A deal was done on those terms—partial EU bailout plus partial default plus everyone pretending there’s no default—and then the details were kicked down the road. But the details haven’t yet been nailed down, and in the interim many of the banks who owned Greek debt have sold it to hedge funds, often based in London, who are less vulnerable to quiet regulatory coercion. And those funds are betting that if they refuse to play nice, ultimately Germany will pony up the full bailout.

Needless to say, to have any hope of prevailing in the negotiations the German government needs to act determined to avoid this. But these kind of games of chicken can, themselves, be very unsettling to markets. Once again the lack of a really good decision-making process in the EU means that every possible solution to everything can fall apart in half a dozen different ways.