By Dan Steinhart, Co-Editor of The Casey Report
Greece’s latest idea to solve its unsolvable debt involves retroactively inserting collective action clauses (CACs) into its indentures. Effectively, the addition of these CACs allows a majority of debt holders to impose decisions on all debt holders. Under a CAC, if a majority of holders vote to accept a haircut, it would be deemed “voluntary” by all holders, which, of course, may disqualify it as a “credit event.” That means that credit default swap (CDS) counterparties wouldn’t have to pay, rendering those CDS insurance contracts worthless. Presumably, those without insurance in the form of CDSs would be most eager to vote for such a policy.
Relationships on such a massive scale, as between governments and banks, can cloud the otherwise obvious line between right and wrong. But respect for and enforcement of contracts is a bedrock feature of any functioning economy, and when governments abrogate contracts at will, that foundation erodes. Imagine how this situation would look among individuals rather than institutions.
Suppose you live in a small, suburban community. One day, there’s a serious fire that spreads to multiple houses. Thankfully, no one is injured, but all 10 houses in the immediate area, including your own, are damaged.
You, being both risk averse and responsible, have excellent homeowner’s insurance, which covers 100% of the damage. While it was a bad day for all, you’re happy that you prepared in advance, specifically for such a catastrophe.
Your community calls a special meeting – apparently, the mayor has brokered a deal with the state government to help the fire victims. It turns out that only you and two of your neighbors have good insurance, and seven do not. You’re sympathetic to the uninsured, but mostly you’re happy that you’re not one of them.
The mayor steps up to the podium. “The state government is willing to help us,” he says. “They’re generously stepping up to cover 50% of the property damage for every house.” That‘s nice, you think. You don’t need it because you’re fully insured, but it’s great that your neighbors will get some help.
The mayor continues: “We just need you to consent to voluntarily accept this assistance in lieu of any private claims. The government and the insurance companies worked together to construct this great deal for you. We’ll hold the vote tomorrow.”
As you walk out of the meeting, you contemplate the mayor’s vague language. They couldn’t really invalidate your insurance policy, could they? Besides, he said they need your consent. You’ll simply decline.
Later that day, you call your insurance company to discuss your claim. Much to your surprise, the agent responds, “Actually, claims related to that fire are on hold pending the community vote.” “Oh, I’m not participating. That’s why I have insurance,” you assure him.
“Actually, whether or not you’re participating depends on the outcome of the vote,” the agent says. “Your policy has a collective action clause.” He continues, obviously reading from an official document: “If a two-thirds majority of fire victims vote affirmatively to accept the government assistance, then a ‘fire event’ is deemed to not have occurred.”
Fire event? Is he saying that your neighbors can vote away the definition of a fire? For the first time, you get a sick feeling in your stomach. Did you miss something in the fine print when you signed the policy? You frantically scan your agreement, and much to your relief, no such language exists. You confidently inform the agent.
“Yeah,” he says. “You won’t see it in your paper contract. The policy was retroactively outfitted with the collective action clause after the fire. Government’s orders.”
Stunned and increasingly angry, you fume, “The mayor said you need my consent for this. I don’t give my consent!”
“Like I said, sir, if two-thirds of your neighbors vote affirmatively, they’re consenting for you.”
You hang up abruptly. Why did you pay insurance premiums for all those years? What’s the point of entering into any contract if its terms can be changed at will, without consent of both parties? And who in his right mind would call this voluntary?