Greece, last week, passed its Collective Action Clause legislation in preparation for its upcoming bond swap, wherein bondholders have agreed, in general, to a write down of some 53%: they’ll trade the bonds they hold for new bonds issued by the Greek government that will run out to just over half the value of those original bonds.  This was a—more or less—voluntary swap: agree to the deal or risk losing everything as Greece explicitly defaults.

However.

What the CACs do is force all bond holders to make the swap, whether they want to or not, once a minimum per centage of holders make the swap.  It’s important to note here that this was done retroactively—years after the bonds had been sold, years after a solemn debt agreement had been committed to by the Greek government (and the bond purchasers, but they’re not the ones making this commitment change).  In short, the CACs change the original terms of the debt, and they do so entirely unilaterally, and only after the fact.

There are two problems with this.  One, the most important, has to do with integrity and morality.  The Greek government, and the Greek citizens collectively, can be derided for their foolishness in running up so large a debt compared to the country’s ability to repay, and many of us have done so.  However, to things that are known a priori on any debt sale agreement are that there is a non-zero possibility of default, even on a government debt, and this is priced into the cost of buying a sovereign debt instrument, at however small a premium.  The other thing that is known is that the terms of the deal will be honored by all parties to it, come what may.  Even were the Greek government, for instance, explicitly to default on its bonds—to go through, for instance, the (inter)national equivalent of an American bankruptcy court proceeding—everything would proceed in accordance with already known rules and conditions.

This unilateral, retroactive change to the terms of these debt agreements, though, destroys that integrity, that morality.  An entity that will welch on its commitments as soon as they become inconvenient (albeit a large inconvenience in the present case, but there are more honest alternatives even here) cannot be trusted to honor any future commitments whenever those might become inconvenient.

The other problem is a moral hazard one; although this one has a chance of not materializing.  The moral hazard here is not the classical economist’s moral hazard, but a different kind.  Consider, for example, a basketball or soccer player who hits the game winner as the clock expires.  This player gets credit—gets the positive moral hazard—for hitting the winner.  Never mind that this is wholly unjustified: his teammates and he have spent the entire game keeping it so close that a single shot out of the 150 or so in an NBA game or dozen or so on goal in a soccer match, makes the difference.  Any shot from the first one taken in the first quarter to the penultimate one taken late in game, any of those, has significance equal to that last one made.

So it is with Greek bond holders in a more negative sense.  Suppose the required per centage of bond holders, less one, makes the swap.  The swap fails, and the Greeks default.  It’s easy to identify the game winning shooter and to lionize him.  It’s also easy to identify the bond holders who reject the swap, and I suggest that the last one to make that list will not be lionized.  All bond holders are put into this box, also, though.

Under these circumstances, I ask again my question: why would anyone buy this country’s debt in future?  An actual “I can’t pay, so I default” would bring about sore hits to Greece’s future borrowing capacity, but such a default would not, of necessity, impugn Greek honesty.  They would recover, and in pretty short order.  But having destroyed their integrity?