When people are bad credit risks,
- banks stop lending to them, or
- they require collateral for the loans, collateral that hasn't already been used to secure other loans, or
- they require that borrowers induce someone else more credit-worthy to co-sign the loan.
So why have investment banks, hedge funds, etc. been willing to lend money to Greece and Puerto Rico (and California and Illinois, for that matter)? These entities have nothing to pledge as collateral for the loans, and so it must be related to co-signers or some expectation of a bailout (which is, de facto, what having a co-signer for a loan provides).
During the various Latin American debt crises of the early 1980s, I asked Grant Reuber, then COO of the Bank of Montreal (and former Dean of Social Sciences and Academic VP at UWO), about BoM's apparently perilous exposure to that debt. His response then was, "All they have to do is service the debt." What he meant was that so long as the countries could make the interest payments on the debt, the Bank of Montreal and many others were perfectly happy to keep re-funding the debt.
The big debt crises arise when major lenders become concerned about whether
- the big borrowers will be able to continue to service their debt, and hence
- the big borrowers will be able to borrow more and borrow again to re-fund their debt.
Three or four years ago, I'd have been willing to consider taking a flyer on some short-term Greek debt. I figured something would work out for repayment of the Greek gubmnt debt. I might have done ok if I had -- then. During the last year or two, I wouldn't have paid more than ten cents on the dollar (so to speak) for Greek bonds.
Nevertheless, during the past year, why have people been buying the Greek (and other) debt? In general it must be because they expect someone to bail them out, whether it be the IMF, the ECB, or the US gubmnt. In other words, buyers of the debt of these debt-ridden political entities are speculating that somehow those entities will be bailed out.
And so, in the end, who is being bailed out? In far too many instances it is the lenders, not the borrowers, who are being bailed out. It is the owners of the bonds who get bailed out if some other entities pony up the money to repay the debt. The present situation is not unlike the farm "crisis" of last decade in which farmers were ostensibly being bailed out, but it was really their creditors who were the beneficiaries of the bail-outs (at least in large measure, usually [There -- did I hedge that assertion enough?]).
In the case of Greece, that isn't likely to happen. They have already made it clear that lenders must provide concessions (i.e. seek less than full repayment of their loans). Similar noises are being made by Puerto Rico. When a borrow seeks "concessions", they are in fact negotiating what to do about impending bankruptcy.
At this point, Puerto Rico (and California and Illinois) can probably count on US gubmnt aid, which means that buyers of their debt can probably count on being bailed out. But one wonders how long this situation can persist.