CDS demonization watch, Greece edition

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Original posted on Reuters by Felix Salmon:

My CDS Demonization Watch has been on the backwards burner for a while: I intellection that the procession had moved on. But right now, the most-read news in the NYT playing section, getting a aggregation of attention in the Twittersphere, is this one, headlined “Banks Bet Ellas Defaults on Debt They Helped Hide”. It’s gaining a aggregation of traction: Ben Bernanke said today that he’s hunting into the supply of whether the CDS mart is sanctioning whatever category of run on the Hellenic government. I truly wish he was meet cosmos polite to his Congressional overlords, kinda than purchase in to this theory.

It’s worth hunting at the NYT news in whatever detail, to wager meet how lowercase significance it makes.

Bets by whatever of the aforementioned banks that helped Ellas shroud its mounting debts haw actually today be pushing the commonwealth closer to the bounds of business ruin.

Echoing the category of trades that nearly toppled the American International Group, the increasingly popular shelter against the venture of a Hellenic choice is making it harder for Athinai to improve the money it needs to clear its bills, according to traders and money managers.

The first abstract worth noting here is that Ellas is not anywhere nearby the bounds of business ruin. The CDS mart is actually rattling good at display when a borrower is nearby business ruin: when that happens, spreads notch discover past 1,000bp to something closer to 2,000bp or modify 3,000bp. Greece’s CDS spreads peaked at about 400bp, which is broad for an EU country, but is nowhere nearby worried levels. Yes, every instance the CDS distribute rises it gets closer to distress, but that’s meet as genuine â€" and meet as unconstructive â€" if it goes from 30bp to 40bp.

The ordinal saucer to note about these opening two paragraphs is the peculiar presence of AIG. AIG went assail because it wrote insurance; the NYT news is here implying that there’s whatever connexion to what’s event with Greece, a meaning assign that grouping are composition shelter on. AIG had to clear discover zillions of dollars to attain good on CDS contracts; Ellas has neither bought nor sold whatever CDS contracts at all. No sooner are the parallels prefabricated than they break down.

That doesn’t kibosh the NYT, however, which then proceeds to rotate discover the cliché about CDS cosmos “like purchase fire shelter on your neighbor’s house”. The difficulty is that the faith meet doesn’t work in this case. Much after on in the article, after most grouping hit stopped datum it, we’re told the truth of the matter:

European banks including the land giants Credit Suisse and UBS, France’s Société Générale and BNP Paribas and Deutsche Bank of FRG hit been among the heaviest buyers of swaps insurance, according to traders and bankers who asked for anonymity because they were not authorized to interpret publicly.

That is because those countries are the most exposed. French banks hold $75.4 1000000000 worth of Hellenic debt, followed by land institutions, at $64 billion, according to the Bank for International Settlements. German banks’ exposure stands at $43.2 billion.

These banks aren’t purchase shelter on someone else’s house, they’re purchase shelter on their own house. As the old locution goes, if you owe $75,000 to the bank, you’ve got a problem. If you owe $75 1000000000 to the bank, the slope has a problem. And in this case, the banks are doing their best to deal with that difficulty and control their venture proactively.

The discourse here is whether their ability to do so in the CDS mart is intensifying matters for Greece. The execution here is complex, if it exists at all:

As banks and others rush into these swaps, the outlay of insuring Greece’s debt rises. Alarmed by that bearish signal, bond investors then shun Hellenic bonds, making it harder for the land to borrow. That, in turn, adds to the anxiousness â€" and the whole abstract starts over again.

At the rattling least, this does a large injury to bond investors. They’re not sheep who are bright to add to whatever land unless or until its CDS spreads widen â€" in fact, at the margin, they’re more likely to add to a land if they undergo that they’ll ever be able to hedge that position in a liquid CDS market. Now, it’s genuine that as worries over Greece’s creditworthiness intend more intense, Greece’s outlay of assets goes up. But there’s a strong housing to be prefabricated that absent the CDS market, Ellas only couldn’t take at all: the cosmos of the CDS mart has prefabricated it easier (if more expensive) for Ellas to take money, not harder.

There is a unification between the CDS mart and the change bond market, thanks to the construct of delta equivocation â€" grouping who delude assign protection on Ellas will ofttimes modify up commerce Hellenic bonds at whatever saucer in visit to control their exposure. But that unification is much more tenuous than the alternative, which is that of banks hunting to turn their Ellas exposure every dumping their Hellenic bonds onto the mart at the aforementioned time. The termination of that category of operation would be spreads much wider than 400bp.

The weirdest bit of every in the NYT article is the way it places the blessed not on grouping trading Hellenic CDS, but kinda on grouping trading a more generalized sovereign CDS index:

Last September, the company, the Markit Group of London, introduced the iTraxx SovX Western aggregation index, which is supported on much swaps and let traders adventure on Ellas shortly before the crisis. Such derivatives hit acknowledged an outsize role in Europe’s debt crisis, as traders pore on their regular gyrations.

If you poverty to adventure on Greece, you crapper adventure on Greece: recreation on a broader Western aggregation finger makes lowercase sense. What’s more, insofar as grouping are trading the iTraxx index, they are rattling implausible to delta-hedge in the bond mart â€" they’re meet taking positions for a some hours or days, trading in and out. Blaming the iTraxx finger for Greece’s problems makes no more significance than blaming the ABX finger for the subprime crisis: it’s a symptom, not a cause.

But by farther the poorest part of the NYT piece is its headline: at no saucer in the article does it become near to making the housing that banks in general, or nihilist Sachs in particular, are betting on a Hellenic default. At worst, banks are equivocation their large exposure to Ellas and another PIGS nations using an finger they helped to create. But the fact is that Greece’s financing charge â€" the denomination of the NYT webpage is “Trades in Hellenic Debt Add to Country’s Financing Burden” â€" is every its own making. Blaming the banks here makes no significance at all.

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