Germany in catch-22 as debt insurance costs hit record
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So much for Germany being insulated from the euro zone’s troubled periphery. German credit default swaps are already beginning to price in the country’s worst nightmare: that it will have to pay a hefty bill for a deepening euro zone debt crisis.
The cost of insuring 5-year German debt against default rose more than 50 percent over the past month to a record high of 118 basis points. French CDS rose around 11 percent over the same period to 189 basis points, according to Markit data. The rise indicates investors are beginning to associate greater risk to holding German debt, even as the triple-A rated bond continues to benefit from safe-haven flows. German Bund futures saw their biggest quarterly rise between July and September since the launch of the euro.
The problem is Germany, the largest sovereign contributor to bailout funds already agreed for Greece, Portugal and Ireland, is expected to pay a high price for any solution to the debt crisis or, given its banks’ high exposure to peripheral debt, for any failure to resolve it.
It could suffer if Greece eventually defaults, as many in markets expect, and if contagion spreads to other peripheral economies. German banks are the second most exposed to Greek and Italian debt and are the biggest holders of Spanish bonds with $177.9 billion in their books, according to data from BIS as at the end of March. Jennifer McKeown, senior European economist at Capital Economics, explains the dilemma:
Developments seem to be edging towards Germany taking on more and more risk relating to peripheral economies. And of course even if there aren’t further bailouts for those economies, Germany’s banks are exposed to the peripheral countries, so they are at risk anyway.
German CDS may also be reflecting hedging of long positions in the cash Bund market, said John Davies, fixed-income strategist at WestLB.
The extent of the burden on Germany will depend on how exactly euro zone policymakers decide to go about solving the crisis. Euro zone ministers were meeting to discuss increasing the power of the 440-billion-euro bailout fund via leveraging but without increasing guarantees that back its borrowing.
Steps towards more fiscal integration could increase the burden on Germany but might also arrest the deterioration of the crisis. The alternative could be even more costly, some say. Billionaire investor George Soros argued as much in a recent opinion piece:
A breakdown of the euro would precipitate a banking crisis beyond the global financial authorities’ ability to control. The longer Germany takes to recognize this, the higher the price it will have to pay.
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While it is common practice, in some circles, to call a credit default swap (CDS) insurance, a CDS is not an insurance policy but a derivative which a speculator has written and which the holder is using to hedge its position. The original CDS writer is not an insurance company, regulated for necessary the required insurance reserves and which writes CDS on the required actuary basis. While it is true that some insurance companies (AIG) wrote CDS, they were not writing them on their insurance book.
Just who, or what, would be able to underwrite the cost of a credit default swap in Germany?
That being the case, why was no default insurance covering greece?
Part of the last meltdown was caused by finding out that default insurers had no means to cover their losses.