Don’t Sweat the Greek CDS
NOW that we can see what the Greek bond deal looks like we can now see that the Greek CDS contracts will almost certainly be triggered. These are those toxic waste derivatives which are going totally destroy western capitalism. Man.
Sadly for the conspiracists they’ll do absolutely no such thing for two reasons.
The first is that as the FT reports, there’s piss all of these contracts around.
The use of collective action clauses in Greek bonds, as part of the country’s sovereign restructuring, seems set to trigger credit default swaps. For the $3.2bn of net notional still outstanding on the contracts, it’s been a long road to a credit event.
This is less than 1% of the outstanding bonds. It’s just not an important number.
However, the second reason it really, really, doesn’t matter is a little more complex.
A CDS is a credit default swap. Essentially, an insurance contract. I’ll give you some money now, some more money every six months, and then if my bonds go bust then you pay me the value of the bonds. If they don’t go bust then you keep the money I’ve given you. It’s insurance.
Now these contracts did bring down a large company, AIG Financial Products, those few years back in the crisis. So why won’t they do the same now?
The basic way a CDS works is that if my bond starts to lose value, which is pretty much the same as saying the chance of it going bust is rising, we don’t actually wait until it really does go bust for you to pay me. What you actually have to do is post collateral every day. If the value goes down by $1 then you must put $1 in my account. If it rises by $1 then I send you back$1. So whatever the market says is the likely loss at any one time has already moved bank accounts. It hasn’t changed hands legally, it’s still your money, but it’s in my bank account, not yours.
That’s the way it normally works: except, back when, if you had an AAA rating. Then you didn’t have to post this collateral. You could just keep collecting the premiums and only if the bond really went bust did you have to pay out. Which was lovely for AIGFP, they got lots of premiums and didn’t have to post any collateral.
Then they lost their AAA rating. And suddenly all those accumulated losses on all those CDS contracts they had written had to be paid. Now please. Hundreds of billions of $. No one has that sort of money lying around which is why the US Govt had to pay it for them and now owns 80% of the company.
So, why can’t this happen this time?
Well, two reasons: one is that there’s no one left with an AAA rating to write CDS contracts, so everyone who is writing them has had to be posting that collateral every day. So any losses, the money’s already moved. The second is that they changed the contracts so that even if you do have an AAA you’ve still got to post that daily collateral.
So there we have it. The Greek crisis might not actually be solved, they might need another bailout, this one might not even happen. But whichever way around it goes we don’t have to worry about the CDS contracts.
Because, in the context, there’s only a Mickey Mouse amount of them around and secondly, anyone who is going to lose money on them has already lost the money and coughed up. So if it was going to be a problem it already would be a problem.
Image: Employes at the state-run Workers’ Housing Organization, OEK, chant slogans as they hold a banner witch reads ” do not close down the OEK” on Thursday, Feb. 23, 2012. Greek lawmakers on Thursday debated emergency legislation to approve a massive bond swap that would wipe euro107 billion ($142 billion) off the country’s privately-held debt, as new projections showed the economy will suffer the worst contraction in Europe this year.(AP Photo/Petros Giannakouris)