The nonsensical political rhetoric on Greece

By Felix Salmon
March 1, 2010
district covers all of the big Wall Street firms in Midtown -- as reported in the FT:

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Can someone explain to me why and how politicians seem to be particularly susceptible to getting the issue with Greek credit default swaps completely backwards? And why reporters simply parrot their nonsense, rather than calling them on it?

Exhibit A is Carolyn Maloney — my very own representative in Congress, whose district covers all of the big Wall Street firms in Midtown — as reported in the FT:

Ms Maloney compared the use of credit default swaps in the Greek situation to the “activities that brought down American International Group”, referring to the US insurer that collapsed and was bailed out in September 2008.

Er, no, Carolyn. The activity which brought down AIG was the fact that AIG sold a lot of credit default swaps on subprime mortgage bonds — essentially insuring those bonds against default. When they defaulted, AIG became insolvent. Greece, by contrast, has never written any credit default swaps on anybody. If there’s any issue with CDS in Greece at all, then it’s with people buying CDS on Greece — insuring themselves against the risk that Greece defaults. There’s no “shocking echo”, to use Maloney’s words, of AIG in Greece at all, except if you don’t understand the first thing about how credit default swaps work.

Exhibit B is German financial watchdog BaFin, as reported by Reuters:

Germany has taken steps to identify speculators in Greek debt to try to prevent them from profiting unduly from any bailout of the ailing euro zone economy, a source with direct knowledge of the matter told Reuters…

“It would be bad if it were to emerge after a rescue that the money had gone into the pockets of speculators,” the source told Reuters.

“The result of the ‘Greek tragedy’ is that the political environment has become such that the Credit Default Swap (debt insurance) problem has come to the fore.”

Again, this makes no sense, since if there’s a problem here it’s with people using the CDS market to bet against Greece. If and when Greece gets bailed out by Germany, the bailout will enable Greece to pay its debts, and anybody who’s short Greece will lose money. What’s more, the CDS market is a derivatives market, which references Greek debt but which sees none of the cashflows from it. Any money flowing from Germany to Greece will end up in the pockets of Greece’s bondholders, where it belongs — there’s really no mechanism at all whereby it can end up in the CDS market.

So how could these evil speculators profit “unduly” from a German bailout of Greece? That key question is never asked, or answered. Yes, it’s possible that somehow they’re betting on volatility in Greek debt, rather than making big directional bets, and that activity in the CDS market has increased that volatility. But even then a German bailout would almost certainly reduce volatility, and therefore the profits on their trade.

But of course it doesn’t matter that these political actors are making no sense: it’s all a big Kabuki, wherein anybody bashing banks in general, and Goldman Sachs in particular, gets automatic political brownie points. And there are no points at all, it seems, for basic financial literacy.

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