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Greece could face imminent default

By day's end on Thursday, we should know whether Greece will officially default on its debt.

Private holders of $272 billion in Greek debt must decide by then if they will trade their bonds for a package of new bonds and cash worth about 53 percent less than the value of the existing assets. If three-quarters of investors agree, then the deal will be designated as voluntary, and Greece would avoid a default. Yet only days before this vital deadline, no one is certain how it will turn out.

If 75 percent of the holders don't agree to the cut, then Athens will force investors to take the hit by invoking the  "collective action clauses," which the Greek government inserted retroactively into the bonds last week to guard against just such a bondholder revolt. But if fewer than 66 percent of investors accept the deal, those clauses would be invalid, and the entire agreement would collapse. Greece would default.

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According to German weekly magazine Der Spiegel, the European Central Bank is already warning that it expects enough bondholders to bow out of the deal to trigger a default. By contrast, the Institute of International Finance, a group that includes a dozen major investors in Greek bonds and that helped craft the current deal, said it would accept the offer. The IIF is estimated to hold slightly less than a third of Greece's debt; roughly one-fourth is held by hedge funds, and the rest is owned other independent investors.

What happens if Greece goes through an involuntary, or disorderly, default? Nothing good. According to a recent IIF report leaked to the press, losses are likely to exceed a trillion dollars and would include:

  • $96 billion in direct losses owed to both private and public sector creditors
  • An enormous loss to the European Central Bank, whose exposure to Greece via loans, bonds, and guarantees is estimated at about $234 billion, or 200 percent of its capital
  • $211 billion would be needed to recapitalize bankrupt banks
  • Nearly $1 trillion in funds would be required to prop up the economies of Ireland, Portugal, Spain, and Italy, as contagion fears drove investors to withdraw funding

While it is already clear that Greece can't repay its debt, it won't officially be in default until the issue of this deal is resolved. The bond-swap agreement has come under heated criticism. Not only will it cost private bondholders a bundle (and likely cause unemployment to soar in Greece for years to come), but it will cut the nation's debt to only 120 percent of GDP, an amount that is still totally unsustainable.

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