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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And the short sellers caused Enron to go into bankruptcy?

Posted by comment1 | Report as abusive

To amplify your point, If any “money had gone into the pockets of speculators,” it would have come from the pockets of their counterparties, not from the bailout.

Still, AIG and Greece both have a capital G in their name. Greenpeace and Georgia should both be placed under closer scrutiny.

Posted by dWj | Report as abusive

Maybe you take a read at a view from Europe: The House is
on Fire ! by Paul Jorion
“Ladies and gentlemen of the European regulatory authorities, I am today turning to you: the house is on fire!
Demands that Greece lowers its civil servants’ wages will not save her. Your prodding Greece to tackle tax evasion will not save her. Your offer to establish a… piggy bank (how laughable an idea!), will not save her either. All that is far too little, far too late. It is also beside the point…”

Posted by amsterdammer | Report as abusive

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.


Hypothetical: European bank owns Greek debt. European bank is nervous about Greek default, so buys CDS protection from CDS market. CDS seller, with inside information about pending bail-out (say), walks away with free cash.

So the bail-out money flows to the holder of Greek bonds and from there to the seller of the CDS. Seems like a pretty clear mechanism to me.

The way to avoid this is to make sure the Eurozone banks are not “wasting money” on CDS if a bail-out is coming. As far as I can tell, that is the only reasonable interpretation of the quote from the mysterious “source”.

P.S. In general, arbitrage insures there is never all that much difference between derivatives and underlying. Markets are like that. :-)

Posted by NemoP | Report as abusive

If I didn’t know better I’d say there was something awfully chauvinist about Felix’s scolding of “Carolyn” for not knowing the “first thing about how credit default swaps work,” unlike big boys like himself.

Posted by Wismar | Report as abusive

While, on first glance, I agree with you about Carolyn Maloney, it does seem possible for a “speculator” to profit from a bailout of Greece: simply sell a CDS. I have no idea whether it is possible to short-sell a CDS contract, but even if it’s not, one could presumably create a new CDS and sell it.

Since there is no regulatory requirement to keep back-stop capital against the possibility of a claim against the CDS (as fatefully exploited by AIG), the only limit to potential profit by somebody who successfully forecast a bailout would appear to be in the curvature of demand for default protection.

Posted by JohnBarrdear | Report as abusive

I was watching CNN Zakaria’s GPS and it was stated that a German worker would have to delay their retirement by a minimum of 2 years from age 65 to 67 in order to allow a Greek worker to retire at age 55…I’m moving to Greece!

Posted by csodak | Report as abusive

Wismar: I assume some sarcasm in your post. If I’m right, I suppose you believe that a male journalist ought never to call a female politican clueless, even when she is in fact clueless based on the evidence of her quote? Is this attitude not more chauvinistic than simply calling ‘em like you seem ‘em in a gender-neutral fashion? Do you think a woman who makes it to the U.S. Congress representing Manhattan is such a delicate flower that she can’t accept a bit of criticism on the facts?

I’m not sure why, three years into massive discussion of CDS, we haven’t yet reached the obvious conclusion that CDS are indicative of speculators dealing with other speculators in a zero-sum game. The only regulations they require are clear marketing rules so that banks can’t stuff retail/pensions too aggressively and clear collateral/netting/resolution rules to minimize systemic risk. If you think they’re temporarily dislocating credit markets you should be THRILLED about the prospects of free reversion-to-the-mean profits. If you think more information about speculative interest (which is all it is, since every one of these trades has two sides) is sufficient to bring down healthy institutions, perhaps you need to enquire a bit more closely into the stability of these supposedly healthy institutions. A truly healthy institution can pay a slightly larger spread in uncertain times until it proves its worthiness to the markets. Those whose business model has no volatility tolerance deserve to fail and benefit the rest of us by their departure.

Posted by najdorf | Report as abusive

Never mind the rhetoric – it’s the Goldman Sachs Pistols!

Posted by HBC | Report as abusive

Never mind if you are pro or against CDS. Just tax them heavily…

Posted by M.G.inProgress | Report as abusive

JohnBarrdear- good point, there is no regulatory requirement to set aside capital against an event of default.

Since anyone can trade CDS’s, why don’t you just sally into the market offering to write say 100 billion euros of protection on Greece?

I’m sure you will be accepted as a creditworthy counterparty.

Posted by johnhhaskell | Report as abusive

Well technically, AIG became insolvent because of two facts:

1) The price declines on the underlying bonds – not defaults – triggered more collateral payments.
2) The downgrades of AIG also triggered more collateral payments.

The defaults on the subprime bonds were tangential to AIG’s bankruptcy.

Posted by Danny_Black | Report as abusive