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The response to the financial crisis is a trail of unforeseen consequences. Here's at least one that could be lurking in the latest program to contain Europe's debt crisis.







Europe's leaders are bending over backwards to avoid a "credit event" that would allow investors to redeem all the insurance they have bought on Greek debt in the form of credit default swaps.







A key component of the European program agreed in the wee hours in Brussels on Thursday is getting Greece's debt down to a manageable 120 per cent of GDP. That effort involves Greek bondholders taking a 50 per cent loss on their investment, up from a previous agreement to take a haircut of 20 per cent.

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This constitutes a default by any reasonable definition. But Europe's leaders are trying very hard to frame these losses as voluntary, which would avoid triggering a broad Greek CDS redemption. The European plan says leaders will "invite" private investors to develop a "voluntary bond exchange with a nominal discount of 50 per cent on notional Greek debt held by private investors."







Steven Tananbaum, managing partner and chief investment officer at GoldenTree Asset Management says Europe's leaders are undermining the CDS market by blurring the conditions under which investors who purchase insurance against sovereign default might actually get to use it.







Given how some investors use the CDS market purely for speculative gains, politicians likely won't lose many votes by using their influence to avoid redemptions. The market volatility that would follow an unambiguous default might also justify a liberal interpretation of the definition.







But the economic risk is that hedge funds and other investors give up on the CDS market. Not all money mangers treat the CDS market like a casino. Many purchase insurance on their investments to reduce the risk on their balance sheets. As Mr. Tananbaum pointed out at the Economist magazine's Buttonwood conference in New York on Thursday, that could result in less investing and by extension, less growth.







"If you can't hedge your position, you shrink your position," Mr. Tananbaum said.





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