Embrace reality, not fight speculation

March 2, 2010

Stock up on canned goods, the authorities appear to be opening a new front in the War Against Speculation; this time taking aim at the people who might profit from Greece and its European partners’ woes.

Just days after the U.S. Securities and Exchange Commission voted new limits on short selling, Germany is investigating the credit default swap trading of speculators to try to prevent them from profiting from any bailout of Greece.

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

French Economy Minister Christine Lagarde on Sunday said that derivative trades on sovereign debt should be tightly regulated, limited or even banned.

That’s right, apparently there is a big problem out there and it is that greedy speculators are betting that governments that look like they will have difficulties paying their debts might, well, have difficulties paying their debts.
Even worse, some are betting that since there is no tenable alternative to Greece being bailed out that it will be, well, bailed out.

I’m not sure if this is a war against speculation, against lese majeste or just against reality.

Fighting reality by punishing people who point it out, and, yes, may profit in the process, is a lot easier than addressing the fundamental underlying issues. Greece stands accused of fabricating its economic data, of borrowing too much and of using the proceeds not to fix the leaking roof but to expensively tile the kitchen. Greek wages and pensions went up 10.5 percent in 2009, for goodness’ sake.

Further, the lack of an exit mechanism from the euro and the huge problems that a Greek default would pose for banks globally make a bailout a good bet.

These are not problems that can be solved by cracking down on speculation, any more than fraud at Enron could have been cured by a ban on short selling.

This is not an issue that will end with the euro zone. What derivative speculators on Greek debt are doing is little different at its heart than investors selling U.S. Treasuries or British gilts because they feel those countries’ deficit situations are getting out of hand. These are simply bond market vigilantes in another form.

CAUTION, INTELLIGENCE AT WORK
Even better, countries are now so concerned with the dastardly deeds of the speculators they are apparently putting their intelligence services on the job.

Two Greek newspapers reported on Friday the country’s EYP intelligence service was investigating speculative attacks on Greece in financial markets and had identified U.S. and British firms as aggressive sellers of Greek bonds. And the buyers, who were they? Probably best to ask the Germans, who since they are worried about profit from bailouts appear to be right on the case.

Similarly Spanish daily El Pais has reported that intelligence services in Spain, a leading candidate to be next in the line of highly indebted dominoes, were probing “speculative attacks” against the country.

I’ve got a budget saving hint for Greece and Spain: If reports that banks and hedge funds are betting on government debt movements is typical of the value they are deriving from their intelligence service, well then, there are some attractive savings to be made.

Still, there are plenty of good reasons to regulate derivative markets. Credit default swaps are dangerous when they are used, as they were during the bubble, to create credit in the system without a similar growth in banking reserves, bypassing banking safety and soundness regulations. That is in essence what AIG did and was the reason that the shadow banking system drove the inflation in real estate and other assets.

Further, credit default swaps that are traded over the counter are a regulator’s nightmare; it can never be clear whose house a given tree will fall on if it is hit by lightning, and the risks of highly interconnected banks can be amplified.
So, by all means, regulate credit default swaps and force them to be traded on exchanges.

It is always unpleasant to have our faults pointed out, and no doubt doubly enraging to pay for the privilege. The crime of lese majeste, which appears to be at the heart of the current concerns about sovereign derivatives, is not a valid basis for regulation.

On the broader issue, I’d suggest that rather than warring with speculation, euro zone nations would be better off negotiating a peace with reality.

(Editing by James Dalgleish)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

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