Markets Still Worried About Greek Sovereign Debt

At the end of April this year, the markets were very worried about the possibility of the Greek government defaulting on its government bonds. The futures market prices for those debts implied an expectation of a more than one in three change of a default within a year at that time.

European governments put together a bailout plan in early May, which greatly eased market fears of defaults. The resurgent confidence has done its job in terms of market expectations of short term defaults, greatly reducing the market's estimation of the likelihood that there will be a default in the next year.

But, market expectations that the Greek government will default in the three to ten year time horizon are actually higher now then they were before the EMS stepped in with its bailout plan. The prices in the bond markets imply an expectation that there is a 50-50 chance of a default within two years, and close to a 95% chance of a default in the next ten years.

The Council on Foreign Relations piece summing up the probabilities, in my view, overstates the market expectation of some default, by assuming that if there is a default that creditors will be paid 65 cents on the dollar, when I think it is likely that the markets are really assuming that there is a much smaller expected likelihood of a default, but an expectation that if there is one that the payout to bondholders will be much less than 65 cents on the dollar.

Still, there is no doubt that the market is not confident that Greek government bonds are a safe investment, and probably with good reason. There is likewise no doubt that the market things that in the short run, the bailout package has made Greek bonds a safer investment, while the market has a dimmer view of the safety of Greek bonds in the long term than it did before the bailout.

A major truck driver's strike this summer, which disrupted the Greek economy in the middle of peak tourist season until the government broke the strike by threatening to have soldiers do their jobs, certainly didn't help market expectations.

Now, why should we care about whether or not Greek bonds default, unless we own some? The concern is that a major Greek bond default could lead to another financial crisis that could throw the entire world's economy for another loop, possibly even pushing the United States economy into a double dip recession if coupled with other pieces of bad news (the cliched "Perfect Storm").