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Understanding Default Swaps | The Greece flavor

Or teaching newspapers to report it right

I understand popular sentiment is al little against these Investment Banks for their pay and some others but with the NY Times going for journalistic jingoism and trying to put all blame at their door, they are probably readying themselves for trading their own CDS debt from their own short sighted logic.

Greece, Swaps and Default Swaps

Here’s what America’s favourite donkey trooper says about Greece ( and behold we have their treasured brainy jingoism here earlier on the same subject) :

Banks Bet Greece Defaults on Debt They Helped Hide

Bets by some of the same banks that helped Greece shroud its mounting debts may actually now be pushing the nation closer to the brink of financial ruin, Nelson D. Schwartz and Eric Dash report in The New York Times.

Echoing the kind of trades that nearly toppled the American International Group, the increasingly popular insurance against the risk of a Greek default is making it harder for Athens to raise the money it needs to pay its bills, according to traders and money managers.

It’s very clear in the narrative itself, that these are naive journalists taking advantage of new found access in Investment Banking circles, but they end up talking to discredited conventional bankers who can definitely see the precipice, but are not meaningful PR or effective risk managers for their own portfolios, like Unicredit and some other Eastern European junk bond desks.

They may yet realise the disservice they are doing to their profession, or they may not and simply crow on the wrong side like many failed activists. After all, in any educational system 2 out of 3 graduates are unemployable because of such attitudinal gaps and gaps in sensible education to help them bridge the gap. They would probably be trained otherwise if they changed jobs next year.

First- GS did sell Swaps to Greece, because these Swaps are not weakening the debt but they have been widely sold to swap the risk off the books into shorter money market contracts . That’s what likely happened, and even now without swaps that is what the sovereigns in PIIGS countries have to do.

Second- Greece, did fiscal mismanagement, which had nothing to do with this swap of older debt not repayable because the government ever had any revenues.

Third – Default Swaps are sold as insurance because the buyer gets to bet on the safe exit of the lenders and when the lenders are not safe, he is compensated by the wider spread for the sinking boat and finally someone like AIG refuses to pay the indsurance it is holding. That is what spoils the party too. The current investigations into GS are a good start but this piece defeats the purpose , if we are to find the perps.

Four – Thus, Default Swaps would not be sold on the swaps making them off balance sheet but on the underlying debt as they deal with the risk of lender not being paid back. The holder in the final case irrespective of the spread he earned has to back it with the collateral for the lender. A point which the originator tries to enforce, like Goldman did and AIG just refused to pay.

However at the end of the day, CDS is an instrument where contracts have not been enforced and AIG’s have been able to get away, because selfish bankers o want nly the spread. and that is what GS sold it for.

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This entry was posted on February 27, 2010 by in Financial Markets, Financial Services, Global, O'nomics, Uncategorized, US and tagged , , , , , .

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