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PIIGS update: Greece to get a voluntary debt restructuring

The top chart shows the history of 2-yr sovereign yields for the PIIGS countries, while the bottom chart shows the rate on 5-yr Greek Credit Default Swaps. The deal being finalized in Europe that combines more aid to Greece with the "voluntary" participation of private bondholders in a debt exchange (aka restructuring) has had a significant impact on these sensitive indicators of default risk. It's not that a Greek default now has become less likely, it's that the magnitude of the default will be much less than the market feared. And that, in turn, has reduced the likelihood of a sovereign debt default contagion. It's interesting that the ISDA (the International Swaps & Derivatives Association that determines whether a "credit event" has occurred that would in turn trigger the payment of by those who have sold CDS) has indicated that a voluntary restructuring would not necessarily qualify as a credit event.

As this chart of 2-yr swap spreads shows, the degree of systemic risk in Europe hasn't changed much despite the restructuring deal. It's uncomfortably high, but not seriously so. Some banks could be in trouble, but swap spreads of just under 70 bps don't point to an untenable or out-of-control financial meltdown. In short, Europe is dealing with the PIIGS problem in a variety of ways and is likely to survive largely intact. Conceivably, this could all turn out to be a nonevent.

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