Waking up and seeing the S&P futures up 25 pts, one would think that the Europeans had pulled some magic rabbit out of the black hat but the only magic is that they actually agreed on the details that have been discussed ad nausem that we were all well aware of. Thus, the only new news this morning is that there is a deal, rather than news of some new terms that were different than the market expected. That said, getting all the European players to get a deal is news in itself. The ECB also may still purchase the debt of European countries in the secondary market alongside the EFSF. Bottom line, under the assumption that too much debt (enhanced by little growth) is the source of Europe’s problems and the three ways of dealing with it is to write it off, pay it down or inflate it away, slicing Greek debt obligations to private bondholders in half is a real long term solution. It will still leave them with extraordinary debt levels relative to their small and stagnant economy but it’s a big start. With respect to the others in the region, they got to turn the hour glass over with the hope the sand doesn’t run out on them as it did with Greece.
Another major issue behind the scenes of the agreement with Greek bondholders is whether the International Swaps and Derivatives Association rules that it is a default that triggers payments under CDS. Europeans simply believe that if the debt exchange is voluntary, it won’t under current ISDA rules. While voluntary is what Europeans want, the deal last night was voluntary at the point of a gun. The EU’s Juncker said this, “It was the fiercely rendered wish by the people, Merkel, Sarkozy, Juncker, that if a voluntary agreement with the banks was not possible, we wouldn’t resist one second to move toward a scenario of total insolvency of Greece, which would have cost states a lot of money and which would have ruined the banks.” If ISDA declares this strong arming combined with a 50% cut in the value of Greek debt voluntary, it will make a complete joke of sovereign CDS and will potentially destroy this market to the point where it will go away. The unintended consequence of what will be next will be those looking to hedge sovereign exposure, mostly banks, will then have to short sovereign debt or outright cut credit to the region. EU officials better be careful what they wish for the holders of Greek CDS