Thursday, February 25, 2010

Casino Greece

I am lured back from my "sabbatical" to this blog by the more revelation of how "credit-default swaps" derivative products designed to help Greece to "hide" its true indebtedness have come to bite its bottom. Read the full report here.

The following excerpts deserve a few of your minutes:

..."These contracts, known as credit-default swaps, effectively let banks and hedge funds wager on the financial equivalent of a four-alarm fire: a default by a company or, in the case of Greece, an entire country. If Greece reneges on its debts, traders who own these swaps stand to profit.

“It’s like buying fire insurance on your neighbor’s house — you create an incentive to burn down the house,” said Philip Gisdakis, head of credit strategy at UniCredit in Munich....

...But even before that issue became apparent, a little-known company backed by Goldman, JP Morgan Chase and about a dozen other banks had created an index that enabled market players to bet on whether Greece and other European nations would go bust.

Last September, the company, the Markit Group of London, introduced the iTraxx SovX Western Europe index, which is based on such swaps and let traders gamble on Greece shortly before the crisis. Such derivatives have assumed an outsize role in Europe’s debt crisis, as traders focus on their daily gyrations....

...there is fierce debate over what exactly is behind Greece’s recent troubles. Some traders say swaps have made the problem worse, while others say Greece’s deteriorating finances are to blame.

So who or what's to blame? Swaps or Greek fiscal irresponsibility?

The primary problem has to be the latter. If Greece had been fiscally strong, no "hi-tech" derivatives could produce a financial calamity. Those CDS prices would not have gone haywire creating a momentum of their own.

What is not clear to most outside the financial business is how that industry has morphed into a hydra-headed weapon of destruction if you are on the wrong side of the trade.

And the mathematical complexity of those WMD is simply beyond most mortals. Not just WMD, the global financial game itself is beyond the knowledge of most politicians and legislators who are, in theory, there to protect the stability of the society which elected them.

Unless you understand this point, you cannot understand how Wall Street has been able to run circles around Washington in the current financial crisis getting away with the metaphorical murder.

Of course Wall Street has been and is still aided by its intellectual allies in Larry Summers, Geithner and Bernanke who have a natural tendency to think like Wall Streeters.

However, even they, without spent any meaningful time in the trenches on Wall Street, trading day in day out, playing with billions, making and losing in seconds, don't really appreciate how quickly Wall Street can spot an opportunity faster than you can say: "Can you explain this to me, please, slowly?"

two cases in point. When Wall Street understood Washington got scared by the prospect of Great Depression V2.0, the honchos immediately got Washington DC to grant them a banking license to gain access to zero cost funds plus federal guarantees on loans.

With these two de facto cost less blank checks, Wall Street quickly amassed financial assets priced for Armaggeddon. Any surprise their 2009 profits and bonuses were off the chart? They played DC for fools.

Take Greece. Of course the good folks at Goldman Sachs knew what they were doing selling derivates to Greece to postpone its inevitable days of reckoning. Of course they didn't want to hold any Greek papers unless they could quickly off load them to someone else. So Wall Street did two things: they helped create a market for those instruments by financing a new company, Markit in London, to produce sovereign risk indices: iTraxx Sovereign Index.

With that Index and its sub-indices covering Western Europe, Asia and so forth Wall Street created, out of thin air, derivative products that bet on movements of those products. Hence a giant Sovereign Risk Casino came into existence.

Wall Street could then hedge against whatever positions they may have held in whatever sovereign papers in their own accounts. Or for that matter bet against any sovereign risk on a net basis.

Goldman Sachs, according to earlier reports, also sold back to the Greece Central Bank, some of the Greek papers they were holding.

It is not far fetched that Wall Street has been running and managing a global casino for some years. Goldman Sachs and others have been not merely financial intermediaries taught in universities, they are principals themselves by holding positions for their own accounts.

If Uncle Sam had come to its rescue, that global casino's ownership and management would have looked very different today.

But politicians in general and Washington in particular don't understand modern finance. Wall Street has successfully led them to believe the world needs this "casino" and only they, the same crew, can manage it, thank you.

One can be cynical and say politicians are only too ready to be corrupted without knowing how to make an honest living let alone a living on Wall Street, and Wall Street is only too willing and able to lead them by their nose. But is that cynicism too far-fetched?

Back to my sabbatical, friends.

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