“trigger a credit event”
This is the big danger.
A “credit event” is what set off our current great recession.
In our case it was Lehman Brothers’ bankruptcy.
While letting Lehman Brothers fail didn’t seem that significant, it triggered massive liabilities in the Credit Default Swaps market which spread throughout banks and financial firms all over the world.
I can’t help but wonder what the amount of CDS’s on a Greek default is (in trillions of dollars). Or an Italian, Spanish, Portugese, etc. default.
I think it must be pretty substantial, or otherwise the EU (and everyone else) wouldn’t be running around like chickens with their heads cut off trying to delay the inevitable.
The bondholders take (or are forced to take) a haircut. Similarly, make the owners of CDSes take a proportional haircut on their payout. This lowers the stress level enormously for the grantors of CDSes, who are mostly investment banks. Sure, many times the bondholders also own CDSes and so they will take a double hit...but that's life, that's the market.
And just who, in any case, asked the bondholders to buy any of these crappy bonds in the first place? It isn't as if Greece (and Italy, and...) were ever stellar credit risks in the past 60 years, now is it? The bondholders were chasing yield, and their chase came back to bite 'em in the arse.
The bondholders NEED to take a sizeable hit here, in the interest of restoring mkt discipline. And so do the CDS owners. The moral here is: when you make a bad investment decision, YOU MUST LOSE SOME CAPITAL, otherwise -- as we have seen for the past 4 years -- moral hazard runs rampant.
A “credit event” was NOT what set off our current recession.
The NBER put the start of the current recession as December, 2007. Lehman tipped over early in the morning of September 15, 2008.
The recession is and was caused by the consumer’s inability to lever up any more to increase consumption. Effectively, the warning sign was on the wall in early 2007 when borrowers of home equity lines and first-time mortgages started defaulting from the very first payment. There was no more money with which to service new debt. After that, it was a certainty that debt deflation would follow.
Household incomes stagnated since 2002, and with the backslide we’re seeing now, consumers have had (on average) no increase in organic (ie, non-credit) purchasing power since about 1998. The US economy is effectively broken, and easy credit was able to paper over the problems until we ran out of credit to extend to the consumer. You’re seeing the exact same thing happen in student debt now as happened in home construction and sales, as happend in autos, etc.