Greek Credit Default Swaps

There is increasing evidence that Greece may be on the verge of defaulting on it's debt. The New York Times reported that many banks are expecting default on Greek government debt. The expectations of default are indicated by high demand for credit-default swaps. These are contracts that effectively act as insurance if the loan isn't paid. This marks the first instance of real demand for swaps on government debt. The article contends that by purchasing these swaps banks are effectively causing the default because it would be in these banks interest for Greece to default and therefore they would be unlikely to loan new funds. This seems unlikely however given that the purchasers of these swaps hardly represent all holders of loanable funds. It certainly doesn't encourage the Greek government to pay their debts however and that may be contribute to their decision to default. Swaps trading in Greek debt has also spurred similar trading in Portuguese and Spanish debts. While this doesn't guarantee that Greece will fail to pay it is another strong indicator and even more troubling it is a sign that government bonds from developed countries, once considered extremely secure investments, are no longer as reliable and may influence how governments finance themselves and operate in the future.


Matthew said...

I know that we have started making comparisons between Greece and California. Here is an article that talks about California's possibility of default on their municiple bonds.http://money.cnn.com/2009/06/25/pf/california_bonds_trouble.fortune/index.htm

Dr. Tufte said...

This is not the first time there has been an active market for CDS's in the debt of countries.

Also, the CDS market is relatively small compared to the entire market for Greek debt.

I think what we are seeing here is another example of people blaming the people who are actually trading in Greek debt, rather than the people who are creating the debt issues in the first place. Any focus on this market at all is probably a form of "changing the subject" away from the political problems that created it in the first place.