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If, as the saying goes, you are judged by the company you keep, Greece is running with the wrong crowd.
Despite European Union officials dismissing talk of a debt restructuring and reportedly boosting the size of a joint aid package with the IMF, traders of credit default swaps on Greek sovereign debt have taken a dim view of the country’s ability to service its debts.
A year ago, Greek CDS spreads traded in a similar range to Israel and Malaysia. Today, the spreads on Greek CDS place the country in very different company. Sandwiched between Ukraine and Argentina, Greece is now among neighbours who are no strangers to default.
The plight of Greek banks has been a frequent topic of conversation on this site in recent weeks. Now that the country has announced it will draw on emergency aid from other euro-area countries and the IMF, these lenders—who are heavily exposed to rapidly souring sovereign debt and particularly reliant on the ECB for liquidity—have come under further pressure.
In late trading today, the spread on credit default swaps for Greek sovereign debt soared above the spreads for swaps written on the country’s largest banks. This says less about the safety of the banks than it does about the scale of the Greek state’s fiscal distress.
A Reuters story suggests that German government officials are taking steps to “identify speculators in Greek debt to try to prevent them from profiting unduly from any bailout.” The measures that could be taken to prevent such profits are unclear, and the article somewhat conflates investors in sovereign debt with those who invest in credit default swaps linked to sovereign debt.
If the purported goal of the investigation is to crack down on CDS speculators, new data from the Bank for International Settlements should give officials pause. In its latest quarterly banking review, published today, the organisation notes that the net exposure of investors to the sovereign CDS of beleaguered euro area economies is a tiny fraction of the actual sovereign debt of those countries. Thus, assuming CDS traders are largely to blame for pushing up the cost of countries’ refinancing is a rather heroic assumption.
Concerns about derivatives markets’ growing influence over the underlying securities upon which they are based have been around for a while. In the context of CDS, these concerns generally surface when a scarcity of corporate debt threatens the settlement of linked derivatives during credit events (defaults, restructurings and the like). But the notional amount of CDS written on sovereign issues pales in comparison to the value of the underlying debt, so attacking derivatives “speculators” on this front seems misguided.
What’s more, a recent Moody’s report suggests that banks may be buying more protection against sovereign default by Greece, Portugal and other teetering economies for reasons not directly related to growing worries about sovereign default. Derivatives linked to some corporate and sub-sovereign borrowers may not exist, so lenders choose instead to buy “protection on the sovereign on the assumption (hope?) of strong correlation between it and the entity to which they have the long credit exposure,” Moody’s writes. Of course, such correlation could be spurious, leaving banks with imperfect hedges and government officials with misguided conspiracy theories.
Earlier today, the agency auditing America’s bank bailout funds—or the Office of the Special Inspector General for the Troubled Asset Relief Program, if you prefer—published a report about AIG. Specifically, the agency details the efforts of the New York Federal Reserve to negotiate with banks on the other sides of AIG’s ill-fated trades in the credit default swap market.
As the agency describes it, up to US$30bn was authorised in November 2008 to purchase the rapidly souring collateralised debt obligations on which AIG’s trades were based. In the end, US$27.1bn was paid to AIG’s counterparties for the assets. They were also allowed to keep US$35bn in collateral that AIG posted before the government-funded vehicle bought out the contracts.
“Questions have been raised,” the report notes, about whether the deal constituted a “backdoor bailout” of banks that did business with AIG. This remains a contentious issue because the government—as described in great detail in the report—was unable to force “haircuts” on the price of the assets acquired and, even worse, because the majority of beneficiaries from the deal were foreign. (It also didn’t help that the largest domestic recipient was Goldman Sachs.)
Although the sums have been reported before, seeing Société Générale at the top of the list of banks to rake in funds funnelled “inexorably and directly” from US government coffers—quelle horreur!—is reigniting criticism of Timothy Geithner, president of the New York Fed during the AIG affair and now US treasury secretary.