Hey protesters: Look at what Europe just did to banks!

by Jon Healey

Los Angeles Times
October 27, 2011

The European Union's late-night deal to save Greece from defaulting on its bonds had two ugly elements for banks and other private investors in Greek debt. Those who resent the financial industry for recovering so much faster than anyone else from Wall Street's epic collapse may find some satisfaction in this development. For everyone else, it's a little troubling.

A centerpiece of Greece's rescue is a deal that EU leaders negotiated with representatives of private investors, led by a banking trade group called the Institute of International Finance. The deal calls for investors to voluntarily agree to write off 50% of the Greek debt they hold in exchange for a guarantee that they'll be repaid on the rest.

Although it's better than a 100% loss, a 50% haircut is still pretty bad, at least for those who paid face value for Greek bonds. What makes it worse, though, is the characterizing that the loss is voluntary. That appears to prevent holders of the debt from cashing in the credit default swaps they bought as insurance on the bonds.

To the extent that the average person knows anything about credit default swaps, he or she probably thinks they're exotic and risky financial instruments that amplified the impact of Lehman Bros.' demise. In fact, they can be a useful tool for hedging risk. And if investors can't hedge, they'll be less willing to take chances with their money, restricting the flow of capital. That's a bad thing for the economy.

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