You now have to beware of "facts" on Yahoo's Finance site. Not merely a link, the blaring headline on "Yahoo! Finance" is misleading: Curbing derivatives might hurt, not help, Greece; Curbing derivatives could make it harder for Greece to dig itself out of debt, experts say.
Of course, parsing the title shows the statement is qualified with "might" and "could", but the message is clear. Here is the argument:
Hold on, many experts say: Credit default swaps -- contracts that insure debt --have actually prevented Greece's debacle from worsening. Without them, they say, investors would be less willing to buy Greece's debt. It would likely need a bailout to run its government and service its huge debt. That could threaten Europe's economic rebound.
Without defending Greece's fiscal (mis)management, Greece is correct on the following:
Greece favors banning "naked" credit default swaps on a country's debt. In naked trades, the buyers of the swaps don't actually hold the underlying debt. Yet they can still profit or lose money on the bet.
Papandreou likened this practice to buying insurance on a neighbor's house and then burning it down to collect. Without naming names, he said some U.S. banks that were bailed out during the financial crisis are using naked swaps to make "a fortune out of Greece's misfortune."
Such speculation, he warned, could trigger a "domino effect" of higher borrowing costs for indebted countries around the world.
And how traders love those domino effects.
If an owner of a bond doesn't like the bond, he/she/it can simply sell the bond. If an underwriter of a bond thinks the bond is overpriced (yielding too little), the underwriter can simply not be involved in the deal.
There is no need for "insurance" on defaults, especially when the "default" can be technical in nature (declining rating by rating agencies, as sank AIG). If there is to be this type of bond insurance, common sense dictates that it should be regulated as other insurance products are and must have reserves.
Credit default swaps (CDS) exist to generate fees for Big Finance. The more destabilizing they are, the more trading profits and transactional fees.
It is a sad thing to see Yahoo join ranks with the banksters. Yahoo has lost its mojo. While it never had an especially countercultural orientation, it did cultivate a hip image in its gogo days. Those days are long gone.
In any case, back to the technical CDS argument in the article:
Analysts acknowledge that heavy buying of swaps can temporarily drive up a country's borrowing costs. Greece on Thursday raised $6.83 billion through a 10-year bond issue. It paid a hefty premium to buyers willing to take the risk.
Yet without credit default swaps, the country's borrowing costs "would be even higher," said Brian Yelvington, head of fixed-income strategy at Knight Libertas.
Unable to hedge their bets on Greece's debt, lenders would demand punishing premiums from Greece, and would themselves have to pay more to offset the risk of such loans, said Mikhail Foux, a credit strategist at Citigroup in New York.
"It would be destabilizing for everybody," Foux said. "As soon as you restrict the credit default swap market in even a small way, it will be more expensive to borrow and more expensive to hedge."
Beware anybody from Citigroup opens his mouth. What emanates from it is likely to be stated only to benefit his or her employer, not you.
All this is manifestly false. If the seller of CDS protection actually intends the sale to ultimately be a profitable deal rather than a one-off means of generating a fee (think AIGFP), it will require an extra profit margin from the debt sale. That profit margin can only come by charging the borrower more, meaning a higher interest rate. Out of that excess interest cost comes the cost of the CDS transaction.
The basic rule of economics is that there is no free traded good or service. This applies to adding a CDS wrapper so that an institution can both purchase a debt offering and "insure" against default.
Come on Mr. Foux and all the shills for Big Finance. The world got along fine without CDS. In fact, it may have gotten along better without them than with them.
Either the sale of CDS should simply be banned or they need to be regulated insurance products. If the latter, they should only be allowed to be purchased by the owner of the debt product.
Copyright Long Lake LLC 2010