Banks Bet Greece Defaults on Debt They Helped Hide (NYT)

[heli]

http://www.nytimes.com/2010/02/25/business/global/25swaps.html

February 25, 2010
Banks Bet Greece Defaults on Debt They Helped Hide
By NELSON D. SCHWARTZ and ERIC DASH

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. 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.

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.

As Greece’s financial condition has worsened, undermining the euro, the role of Goldman Sachs and other major banks in masking the true extent of the country’s problems has drawn criticism from European leaders. 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.

A result, some traders say, is a vicious circle. As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that bearish signal, bond investors then shun Greek bonds, making it harder for the country to borrow. That, in turn, adds to the anxiety — and the whole thing starts over again... If that sounds familiar, it should. Critics of these instruments contend swaps contributed to the fall of Lehman Brothers. But until recently, there was little demand for insurance on government debt. The possibility that a developed country could default on its obligations seemed remote. As a result, many foreign banks that held Greek bonds or entered into other financial transactions with the government did not hedge against the risk of a default. Now, they are scrambling for insurance. “Greece is not a small country,” said Mr. Raynes, at R&R in New York. “Credit-default swaps give the illusion of safety but actually increase systemic risk.”

[aquart]

1. So who's rushing to outlaw credit default swaps?

[Zenlitened]

2. AIG didn't jump, it was pushed. Now it's Greece's turn?

(Granted, AIG cheerfully stepped out onto the ledge, heedless of the risk, thinking they were too big to FALL. They weren't. They were just lucky enough to have plenty of us little people and our tax dollars to land on. :grr: )