Adriene Hill: In Greece today, lawmakers are voting today on another round of budget cuts. Just yesterday, Standard & Poor’s downgraded the country’s credit rating to “selective default.” It’s a move that everyone expected.
But it got us talking about the difference between that and the messy default Greece has been trying to avoid.
We’ve got Marketplace’s Stephen Beard with us to help sort it out.
Stephen Beard:Good morning, Adriene.
Hill: So let’s start with the basics. What does it mean when we say a country defaults?
Beard: A government has borrowed money, usually by selling bonds. But it gets into trouble, can’t pay the money back — the government defaults. And the bondholders lose their cash.
Hill: Now, Standard & Poor’s has downgraded Greece’s credit rating to “selective default.” What does that mean?
Beard: This means that in S&P’s view, Greece has defaulted, but in an orderly way. It struck a deal with many of its bondholders to repay them a small chunk of what they lent Greece. If this had been a disorderly default, Greece would have suddenly thrown up its hands and said, we can’t pay, we won’t pay. And that, says Steve Barrow of Standard Bank, would have been a much more serious event.
Steve Barrow: If default in Greece had happened a couple of years ago and it had been a considerable shock to people, then the ramifications would be much greater than if it happens, say, within the next few weeks.
Hill: So since this is a selective default instead of a messy one, have we solved the concerns about Greece’s loans?
Beard: Not quite, no, because when banks and other financial institutions buy government bonds, they very often take out insurance policies on those bonds called credit default swaps. This means that if a government does default, the insurer will cover the losses on the bonds. Now the body runs this market in these insurance policies is going to decide over the next few days whether this is indeed a default, which could mean there could be substantial payout by the insurers. Nevertheless, just as the bondholders have been able to prepare for default, Steve Barrow at Standard Bank says so have the insurers.
Barrow: Those banks and institutions that have sort of written this insurance have also made efforts to make sure if they do have to pay up, that they’ve sort of got adequate resources to do that and it doesn’t cost them too much trouble.
He says it’s like you live in Florida, you know a hurricane is on its way — you often have time to batten down the hatches and prepare for the worst. However, hurricanes are unpredictable, and who knows ultimately what damage this crisis could do.
Hill: Marketplace’s Stephen Beard, thanks.
Beard: OK, Adriene.
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