One of the side benefits of Greece taking whatever somewhat irreversible steps it is now taking is that something will happen to CDS written on existing Greek debt and that will mean that we can stop talking about what will happen to CDS written on existing Greek debt and start talking about more interesting things like quasi-CDS written by the EFSF on shaky Eurozone government debt.

For now, though, we've got at least a few more weeks of surprisingly and unsurprisingly ill-informed fretting that triggering the $4bn of Greek CDS will Bring Down The Entire Global Financial System. That seems sort of silly because notionals aren't that big, mark-to-market collateral is mostly being posted, and at this point the marks are pretty close to what you'll get from Greece so it doesn't look like there's tons of unknown unrecognized losses lurking out there.

On the other hand, we're mostly through with the speculation that not triggering Greek CDS will Prove That CDS Is Worthless and thereby Bring Down The Entire Global Financial System, so that's nice. The reason that's mostly over is that it sure looks like Greek CDS will in fact trigger, as Athens has moved to adopt a collective action clause that will flip the Greek restructuring from "voluntary, heh heh heh" to "involuntary" and thus trigger the ISDA restructuring event definition. You can argue that the mechanics of the cash settlement auction will mildly screw CDS holders but I'm not so sure, and in any case this is pretty solidly in the category of derivatives nerdery rather than Bring Down The etc.

So the emphasized part of this is not what you'd call, in the strictest sense of the term, "true":

If anything, the deal has cemented the view that private investors are second-class when it comes to sovereign debt deals and that credit default swaps offer little protection. This will make it very hard for private investors to trust European sovereign debt, setting the stage for further messy bailouts in other troubled European countries. ... Investors who chose to hedge their sovereign debt risk with credit default swaps won't be collecting any cash given the way the deal was structured.

But you could have a tiny drop of sympathy for the rest of it. We've spent much of the last four months or so hearing that the Troika is trying to prevent Greek CDS from paying out. Felix Salmon thinks that the politicians' desire to avoid a CDS trigger is caused by epistemology, and I am always willing to listen to some epistemology:

A lot of otherwise very well-informed people still think that this bailout is like previous bailouts, designed to avert a default. When in fact a huge default is right at its very heart. When the CDS get triggered, it’s going to be very obvious that this is indeed a Greek default. That’s something which bond market professionals are acutely aware of, but it hasn’t really sunk in to the broader popular consciousness.

If the Greeks and the Europeans can structure a deal where the credit default swaps aren’t triggered and the bondholders voluntarily swap their old bonds for new bonds, then it’s actually possible that this misunderstanding could continue well past the bond exchange, to the point that the broad public thinks that we’ve just seen another bailout, and misses the footnote that the bailout was accompanied by the single largest bond default in the history of the world.

But I suspect that the world consists mostly of (1) people who get that Greece is defaulting in a very real not-paying-their-debts sense, and understand at some level things like CDS credit events, and (2) people who don't, and don't. So avoiding a CDS trigger so that people in category (2) won't notice that there's been a default seems like a bit of a stretch.

Which leaves you with the other things. Two possible other goals might be "protect CDS writers" and "harm CDS buyers." If your assumption is that CDS writers are for the most part European banks, then a CDS payout need not Bring Down The Entire Global Financial System for European politicians to be solicitous of those banks' economic interests. (And just because you've taken a pretty harsh mark already doesn't mean you wouldn't enjoy reversing it. Accounting isn't destiny, even for banks.)

Similarly, if your assumption is that CDS buyers are mostly eeeeeevil hedge funds then, well, we know quite clearly how European politicians feel about evil speculative hedge funds betting against European credit. They don't like them. They try to make them go away.

In the abstract it sure does look like private investors are screwed by a deal that squishes private bondholders while sort-of protecting the seniority of official creditors, imposes a retroactive collective action clause, and casts CDS into some doubt for a while and then ends up triggering it but in an annoying way with some possible slippage. But it's important to disaggregate "private investors," and also not to disaggregate too much what's gone on in Europe over the last few months. The creditors that Europe likes - the ECB and national central banks of course, but also big European banks who do a lot of lending to Eurozone governments and who those governments wish would lend them more - make out okay. The official creditors get some seniority; the banks get - well, they get a Troika that fights for their honor a bit on CDS triggering, and more importantly they get oceans of cheap funding from the ECB. All in all the wages of playing along with the official sector look pretty pretty good. Why not buy Italian government bonds? What could possibly go wrong?

The hedge funds who get dragged CAC'ing and screaming into this voluntary exchange, and whose CDS is called into question over and over again, are probably annoyed and maybe they will take their ball and go home and never lend to a European government ever again. I sort of doubt that personally; memories are weirdly short and price makes up for a lot. But you could also easily imagine that a decent portion of Europe would be fine with it: the theoretical arguments for more liquid and deeper markets run up against a visceral distaste for particular kinds of market participants, and the distaste wins. (So: unilateral transaction taxes!)

And that's ... actually not that strange. I used to work with companies issuing equity thingies, and I've described that process here before as a coldly economic determination of a market clearing price. But it's not really, or not entirely. Companies all the time fiddle with the allocation of their securities offerings, even at the cost of maximizing price, because they like some sorts of investors and dislike others. Often the ones they dislike are the same ones France dislikes: hedge funds, arbitrageurs, short sellers, high-frequency traders, etc. Better to give something on price and get stable supportive long-term on-side investors than to price to the last basis point and get an investor base of angry hedge funds.

I'm broadly sympathetic to claims of the form "Europe is screwing private investors and that sets a bad precedent for the future since no one will buy European government debt." (Though of course you have to take those claims in a context of Greece not having any money: someone kind of has to be screwed, and it's just a debate about the mechanics of that.) But this is not really that. Rather, the Greece bailout roughly speaking optimizes who gets what to encourage the long-only, bank-style investors to come back for more - and to discourage the speculative hedge funds from doing so. That really should, in expectation, drive up the cost of financing other shaky European governments. That just may be a price they're willing to pay.