Changing Implied Default Criteria To Create Formal Defaults, PIGS & PIIGS (AIB, IRE, NBG)

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The ratings agencies and outside groups are now saying that Greece is in default, like it or not.  Now let’s go ahead and throw in Irish banks as well, with a real possibility of Ireland after that.  A default by most investors is when a debtor refuses to pay or cannot pay their debt and/or service their debts.  The new trick to force a default is by changing the parameters of a default.

Today’s downgrade on Greece by S&P was down by 3 whole notches to “CCC” based upon the notion that any debt restructuring constitutes a default.  The country is off of CreditWatch Negative, but the outlook remains negative.  In short, any restructuring at all is a de facto default

It was just last Friday that Fitch Ratings warned a Greek default could “tip the fragile funding market for major European banks.”  In short, there is a greater sector risk than there is a risk from the direct losses that would follow if there is a default from the country.

Another article this morning is not pertaining to Ireland as a nation, but it should be considered a true Irish problem.  A ruling from the ISDA puts Allied Irish Banks plc (NYSE: AIB) under official default.  Allied Irish Banks is down only 1.2% in the ADR at $2.35 and rival The Bank of Ireland (NYSE: IRE) is down over 4% at $1.13. We have already argued that these are effectively nothing more than wards of the state being kept alive so that Ireland itself does not have to merge these onto the actual sovereign nation’s balance sheet.

Speaking of Greece, the ADR for National Bank of Greece SA (NYSE: NBG) is down 3% at $1.31 right before the closing bell.

Changing the criteria of a default is perhaps the biggest trick that the credit ratings agencies and independent watch group can do.  Today ,there is a video from S&P with one of its analysts talking about what a double-dip in housing could mean for the major U.S. banks.

Meredith Whitney has warned over and over in 2011 that credit defaults are coming in many states and municipalities as well.

Moody’s has now sounded off as well that it has announced potential changes into how it incorporates government and regulatory support into US bank ratings, and that some supported bank ratings could be lowered as a result.

Maybe a default tomorrow will simply be nothing more than a warning that a default is imminent. Many debt covenants stipulate that if certain conditions arise that it constitutes the same action as if a formal default were to occur.

If these same metrics start getting applied to mortgages and credit cards, the financial system will shut down again and even worse than what we saw from late 2008 into the very early part of 2009.

We have warned over and over that the credit ratings agencies have been very far behind the reality of the PIIGS.  Today should be no shock, even if the definition of a default is changing.  The big question remains, “What happens when Greece does actually default?”….. Please note, that is WHEN rather than IF.  Nations do not have 20% interest rates and higher in today’s zero-rate environment without a default of some sort being factored in.

The credit ratings agencies, the world of bailouts, and now just the analysis of what can constitute a technical default rather than a formal default have all acted to create a no-way-out scenario.

Also, guess what happens when the first true default hits… You have other letters besides “G” in the term “PIIGS” or even in “PIGS.”

It is no wonder that the ratings agencies have now sounded off about the Triple-A rating of the United States.  The big focus is on the current political climate today.  If the ratings agencies ever decide to tally up the total liabilities of Social Security and Medicare versus the future tax receipts, we won’t even have to worry about whether they included all the guarantees that Uncle Sam has with Pension Benefit Guaranty Corp., housing agencies, offshore protectorates, and the rest of our obligations.

Until the impact of the final outcome of the future of these nations can finally be factored into the markets, everyone might as well understand that they are being held hostage.

JON C. OGG