Euro zone shorting conspiracy doesn’t stack up
By Nicholas Dunbar
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
LONDON — Politicians’ attempts to blame hedge funds for the euro zone crisis are desperate. Disappointingly for the conspiracy theorists, the idea that a cabal of Soros-style speculators is engineering a meltdown is an unlikely explanation of current market turmoil. What appear to be coordinated bets against European sovereigns have less sinister explanations.
Firstly, there is the impact of peripheral euro zone debt being re-categorised by traders as a credit rather than a “rates” product. Until the last few months, the political dream of European integration was bought into and reflected in the purchasing decisions of bond investors, treasury desks and supervisors who indiscriminatingly treated all European debt as a single risk-free rates product.
But peripheral debt has been redefined into credit, where spread volatility is used as a risk management tool in so-called value-at-risk (VAR) models. Spain is now in this category, and Italy may be about to join it. For countries that planned their debt issuance calendars on the basis of the old rates-based model, the change has been a shock. Bid-cover ratios in bond auctions have declined, and investors have had to be bribed with higher yields to keep buying.
Secondly, there is model-driven selling by formerly rock-solid investors in response to higher volatility. This has flooded the secondary market for euro zone peripheral bonds. Tightening of the acceptability criteria for derivatives collateral, and increased margin requirements also accelerate this computer-driven contagion.
Lastly, counterparties and investors worried about exposure to European bank debt don’t have easy ways to hedge their positions. The best proxy happens to be credit default swaps (CDS) on European sovereign debt.
These factors have arguably played the most important role in expanding the spreads on euro zone bonds and CDS. One can’t rule out hedge fund skulduggery completely. The rumour that France was about to lose its Standard & Poor’s triple-A credit rating, subsequently denied by the ratings agency, coincided with a 15 percent blip in CDS spreads between Nov. 29 and 30. But the threat of bans and opprobrium may have discouraged the typically more aggressive Europe-based hedge funds from taking outright short positions.
It’s always easy to blame short-sellers for a crisis. But the burden of proof remains on the shoulders of the conspiracy theorists.