M. M. Barnier: Cretinous Twat

Michel Barnier, the European commissioner in charge of financial market regulation, said he would propose controls to curb speculative trading in credit default swaps, (CDS) a form of debt insurance that has been blamed for worsening Greece\’s economic problems.

His measures will target so-called naked selling of CDS, where insurance contracts are sold to buyers who do not own the debt.

As the piece goes on to point out CDSs have not been important at all in hte Greek sage. But try to ban them they will using the Greek issue as the lever.

Where this will get interesting though is in the definition of \”naked\”.

Imagine two scenarios.

1) You own Greek Government debt and are worried, you buy a CDS.

2) You own Greek bank (or corporate) debt and are worried, you buy a CDS.

OK, now, in the second instance, do you buy a CDS on the debt of the specific company or bank that owes you? Sure, you can, but a much cheaper way of insuring yourself will be to purchase on the Government debt. For what you\’re worried about is the general chaos of a government default….the impact upon currencies and all that which would result.

And of course the Government market is hugely more liquid than that in the debt of, say, the Athens Water Board who are the people who actually owe you money.

Now we know what people sorta mean by \”naked\”. That you buy a CDS without owning any of the underlying debt. But does naked include option 2? Will you only be allowed to purchase a CDS on debt that you actually own?

And how will this be defined? If you hold a 30 year bond you can only buy on a 30 year bond (yes, I know, terms are standard at 10 years but….). Or if you hold 30 year 2025, can you only buy on 30 year 2025?

In short, does \”naked\” mean you must own the exact debt you are hedging against or does it mean any debt which is close enough? And what is the definition of \”close enough\”?

No, I don\’t think anyone\’s thought this through either. And, strangely, my best guess is that if you must buy against exactly the debt that you own then the price of Greek Government CDSs will rise as a result. For the market will be hugely less liquid. All of those selling and buying generic 10 year cover on the government debt as a proxy for all of the other possible variations will be blocked out of the market.

And guess what will happen then? Yes, you\’re right. The premium which the Greek Government has to pay to borrow will then rise.

This will therefore make the problem worse, not better. Well done chaps.

BTW, this is being brought in by a man who has never had a real job. SpAd then MP. Minister, Commissioner and MEP. Seriously, what does the recent French Minister of Agriculture know about finance?

4 thoughts on “M. M. Barnier: Cretinous Twat”

  1. I have a different perspective.

    1) You own Greek Government debt and are worried, you buy a CDS.

    If you are worried, either don’t own the debt or demand a higher interest rate. Put another way, does the existence of debt insurance (via CDS or anything else) reduce the feedback the market should be giving to the debtor?

    And guess what will happen then? Yes, you’re right. The premium which the Greek Government has to pay to borrow will then rise.

    This will therefore make the problem worse, not better. Well done chaps.

    OK, making markets less efficient is generally bad, but in cases like this (don’t want to pick on just the Greek government), we want the premium they pay to rise, as that is what will force them to alter their behaviour, i.e. to reduce borrowing, or better yet to stop borrowing altogether.

  2. Ed – that is what has happened. People without CDS on Greek debt were selling the debt thus driving up the yield. The only people keen to buy said debt were people who were holding naked CDS.

  3. diogenes, OK, it sounds as if people are behaving rationally on the whole, which is good. Of course, without CDS there would still be buyers, but only at a much higher yield.

    Which brings me to my other worry about CDS, the sellers. Do we know that they can actually afford to pay up if the Greek government defaults? What about those selling CDS on UK or US government debt? Can one buy a CDS on one’s CDS seller defaulting? 🙂

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