An English translation by Bernard Bouvet of my post “Les spéculateurs sur la dette grecque, neutralisés”.
Last Friday’s ruling by the International Swaps and Derivatives Association (ISDA) that the much talked about Greek debt swap, or the so-called private sector initiative (PSI), does not represent a “credit event” and, therefore does not trigger Credit Default Swaps (CDS) payments, constitutes a remarkable victory against the markets, the first real victory in an asymmetric war started exactly five years ago at the height of the subprime mortgage crisis.
With this decision, sovereign debt speculation is being brought to heel: being effectively neutralised, since a partial default (private holders of Greek debt getting 46.5 cents on the euro), alongside a debt rescheduling and a readjustment of interest rates guided less by speculative motives and more by an objective risk evaluation (taking into consideration the European guaranty), won’t be viewed a “credit event”. If such an array of reasons for depreciation is not viewed for what it should be, then nothing will from then on, at the very least as far as CDS contracts on euro sovereign debts are concerned.
It was long overdue for debt buyers, more accurately, lenders to sovereign states, to acknowledge that the rate tagged onto a loan – the “coupon” – already includes a risk premium, that is calculated specifically to compensate the preferably rare occurrences at such times when the advanced funds won’t be reimbursed, or only partially, such as in Greece’s case.
The sovereign states, having until now unconditionally and scrupulously followed the diktats of the sovereign debt speculators, desperately needing a victory to re-stamp their authority, should be grateful to the ISDA. Its fifteen members committee’s decision was apparently unanimous: an impressive feat, admittedly. What could have been the motivating factor being the consensus? With no explanation – none will be provided, we are being assured – one can only speculate (pun unintended).
The most likely scenario: as representative of all players in the CDS market, the ISDA had to protect the conflicting interests of two very different types of speculators, those who contracted naked positions on the Greek debt (in other word, speculating on Greece’s default without really being exposed to the risk of a loss), and those issuing CDS (with no adequate capital reserves, as permitted under the legal framework – or rather in its very absence). An overall process of risk analysis probably swayed the needle in favour of the “insurers”, their downfall proving more costly and a source of an increase in systemic risk (risk of a collapse of an entire financial system) than the failure of the bettors (the ghost of AIG still haunts memories – that insurance company infamous collapse in the fall of 2008 brought about by the reckless issuance of CDS in the demise of Lehman Brothers and its collateral victims).
If my hypothesis is true, the neutralisation of sovereign debt speculation happened not so much thanks to the sovereign states themselves, but rather to the two opposite types of speculators in that market neutralising each other. With all due respect, if one was expecting the sovereign states to show, once again, some courage, one would probably have to wait indeed a very long time!