Thursday, February 25, 2010

NYT: Banks Bet Greece on Debt They Helped Hide

One would think this is an over the top headline but frankly it appears to be quite accurate.  One can argue banks are simply enablers - without demand for these services there would be no market, which is true.  But like many mortgage products the "financial innovations" of the past decade are akin to selling someone an asbestos laden house and then buying life insurance contracts against said human being.  Boo yah - the new finance based economy is so fun for the marionette players.

Via NYT:
  • Bets by some of the same banks that helped Greece shroud its mounting debts may actually now be pushing the nation closer to the brink of financial ruinEchoing the kind of trades that nearly toppled the American International Group, the increasingly popular insurance against the risk of a Greek default is making it harder for Athens to raise the money it needs to pay its bills, according to traders and money managers.
  • These contracts, known as credit-default swaps, effectively let banks and hedge funds wager on the financial equivalent of a four-alarm fire: a default by a company or, in the case of Greece, an entire country. If Greece reneges on its debts, traders who own these swaps stand to profit.
  • It’s like buying fire insurance on your neighbor’s house — you create an incentive to burn down the house,” said Philip Gisdakis, head of credit strategy at UniCredit in Munich.
  • As Greece’s financial condition has worsened, undermining the euro, the role of Goldman Sachs and other major banks in masking the true extent of the country’s problems has drawn criticism from European leaders. But even before that issue became apparent, a little-known company backed by Goldman, JP Morgan Chase and about a dozen other banks had created an index that enabled market players to bet on whether Greece and other European nations would go bust.
  • A result, some traders say, is a vicious circle. As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that bearish signal, bond investors then shun Greek bonds, making it harder for the country to borrow. That, in turn, adds to the anxiety — and the whole thing starts over again.  (very similar to what happened to Bear Stearns, Lehman Brothers, Merrill Lynch and ironically Goldman Sachs - along with Morgan Stanley, before they ran to the Federal Reserve to hide as a bank holding company)
  • On trading desks, there is fierce debate over what exactly is behind Greece’s recent troubles. Some traders say swaps have made the problem worse, while others say Greece’s deteriorating finances are to blame.
  • But while some European leaders have blamed financial speculators in general for worsening the crisis, the French finance minister, Christine Lagarde, last week singled out credit-default swaps. Ms. Lagarde said a few players dominated this arena, which she said needed tighter regulation.  Trading in Markit’s sovereign credit derivative index soared this year, helping to drive up the cost of insuring Greek debt, and, in turn, what Athens must pay to borrow money. The cost of insuring $10 million of Greek bonds, for instance, rose to more than $400,000 in February, up from $282,000 in early January.
  • On several days in late January and early February, as demand for swaps protection soared, investors in Greek bonds fled the market, raising doubts about whether Greece could find buyers for coming bond offerings.  “It’s the blind leading the blind,” said Sylvain R. Raynes, an expert in structured finance at R&R Consulting in New York. “The iTraxx SovX did not create the situation, but it has exacerbated it.”
  • The Markit index is made up of the 15 most heavily traded credit-default swaps in Europe and covers other troubled economies like Portugal and Spain. And as worries about those countries’ debts moved markets around the world in February, trading in the index exploded.  In February, demand for such index contracts hit $109.3 billion, up from $52.9 billion in January. Markit collects a flat fee by licensing brokers to trade the index.  Markit says its index is a tool for traders, rather than a market driver.
  • Some money managers say trading in Greek swaps alone, not the broader index, is the problem.  “It’s like the tail wagging the dog,” said Markus Krygier, senior portfolio manager at Amundi Asset Management in London, which has $40 billion in global fixed-income assets. “There is a knock-on effect, as underlying positions begin to seem riskier, triggering risk models and forcing portfolio managers to sell Greek bonds.”
  • ... until recently, there was little demand for insurance on government debt. The possibility that a developed country could default on its obligations seemed remote.  “Credit-default swaps give the illusion of safety but actually increase systemic risk.”

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