http://motherjones.com/kevin-drum/2011/06/how-bad-are-credit-default-swapsWhy is the European Central Bank dead set against even a "voluntary" restructuring of Greek debt that would force private investors to take a bit of a haircut on their holdings of Greek bonds? Matt Steinglass thinks their motivations are pretty much what they say they are:
The ECB doesn't believe it's possible to make private holders of Greek debt "share the pain" without precipitating a Greek default. They think if you pressure banks to roll over Greek debt, that debt will become untradeable, which is the same as "worthless"; the ratings agencies will deem the failure to pay at maturity to be a technical default, which may trigger credit default swaps; the Greek banking system will become insolvent, meaning nobody in Greece will have any money anymore; recapitalising those Greek banks will have to be done by governments that actually have money, ie the northern European ones; and ultimately the costs will all fall on the northern European taxpayer anyway. Meanwhile northern Europe's pension funds will be hit by the credit panic, which again will hurt the average citizen. The ECB folks sincerely think there's no way around having taxpayers pick up the bill for saving Greece and the euro.
I would really like to see a more detailed explanation of this. The basic idea here is that credit default swaps are (duh) triggered by a default: when you buy CDS on, say, a Greek bond, you're paying for protection against default. If the issuer of the bond defaults, then you're made whole by whoever you bought the CDS insurance from.
So far, so simple. It's often a little unclear exactly what triggers payment of a CDS, but it's perfectly plausible that even a modest restructuring, whether voluntary or not, would count as an "event" that would trigger lots of CDS contracts. But then what? What are the figures here? Just how much CDS is there on Greek debt? How much would be triggered by default? Who are the main sellers of CDS on Greek bonds? How big would the effect be if they had to pay off bondholders?
More at the link --