Tag Archives: CDS


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!

Le Monde – Économie, Monday 8 – Tuesday 9 March 2010

Here an English translation of La machine infernale, my monthly column for March in Le Monde – Économie.


Only five years ago, we were led to believe that the advertised model of the economic and financial apparatus represented a system that was finally mature: stable because thoroughly predisposed to self-regulate and practically safe thanks to super-efficient risk-spreading.

Self-regulation did not happen. Risk, although atomized, was nonetheless concentrated by the more astute players into enormous portfolios of financial products with, influenced by the economic climate, inflated risk premium; an unavoidable downside correction triggered the implosion of the Bear Stearns, Lehman Brothers, AIG, Fannie Mae, and Freddie Mac.

Computers brought complexification to the credit-based world of finances which from then on prevented it from functioning in anything but bubble mode: euphoria concealed the non-existence of self-regulation, while concentration of risk, for a time minimal, went undetected.

By contrast current events highlight the dysfunctional nature of the economic and financial workings outside the dynamics of an economic bubble. Thus, in the case of the speculation against the Euro, a collection of harmful elements combine in a potent toxic mix.

Sometime during 2001-2002, the European Union turns a blind eye to Wall Street’s currency swaps-disguised loans to member states in order to allow them to comply with the terms of the Euro zone Stability and Growth Pact (SGP). Yet, the increasing complexity of financial products makes it impossible for rating agencies to correctly assess the underlying risk. When the subprime crisis breaks in 2007, rating agencies are rapidly discredited. Vague attempts to reform those agencies suffer the fate of all proposed regulations at the time (with the exception of some, sufficiently innocuous): they are shelved into oblivion. Meanwhile, scientific rigor proving elusive, rating agencies will do with inflexibility.

The downgrading of Greece tainted currency swaps put them just a notch above the trigger for a margin call that that nation is unable to honour. Speculation on the, by now, strong likelihood of Greece defaulting gets under way. By taking long positions in Credit-Default-Swaps (CDS), speculators are “insuring” against a risk they don’t face, but by so doing, increase the likelihood that it materializes. Rising CDS prices, considered as an objective measure of risk, according to the prevailing “efficient market” economic theory, generate a proportional increase of the coupon required upon issuance of new debt by Greece, further penalizing her. A vicious spiral snaps in place that nothing can stop. Like so many dominoes, other Euro zone states are being lined up. Once one is in default, the rest of those still unscathed would be weakened, and speculation will immediately target the next most exposed.

When banks were failing, States provided help. The heat is now turned on States. Only the IMF will be left to stage a rescue. On February 26, an announcement was made, through its president, Dominique Strauss-Kahn that the IMF was ready to take up its role. We count on it: the IMF is surely the last defence line.

Many thanks to “bb”.