The risk of credit default swaps

A general view of insurance company AIG on March 26, 2009 in London, England. What does the Greek government have in common with AIG?

Jeremy Hobson: Now let's get to Greece, where the talks continue between the government and its private lenders. They're trying to renegotiate how much debt Greece needs to repay.

Diane Swonk is off this morning, but we're joined from Chicago by Adolfo Laurenti. He is deputy chief economist at Mesirow Financial. Good morning.

Adolfo Laurenti: Good morning, Jeremy.

Hobson: So Adolfo, lay out the stakes for us. What might happen in Greece and why does it matter to the rest of us?

Laurenti: Well the alternatives are between a nice and clean default with a deal with the bond holders, and the losses contained within the current creditors. Or, as an alternative, a messy default with the bond holders suffering a much larger loss. But then in turn, they may trigger the payments for the insurance of their bond -- the infamous credit default swaps -- and then losses will reverberate through the financial system like a stone thrown into a pond. That's the real concern.

Hobson: You're talking about credit default swaps. These are complicated things, but they are basically the reason that AIG collapsed back in the financial crisis in 2008. Are you saying that if there is a messy default in Greece, we could be looking at another AIG-like situation in Europe?

Laurenti: Exactly. Unfortunately, these credit default swaps lack in transparency, so they are traded over-the-counter. Nobody really keeps tabs about who owes what or to whom. And this can be very destructive to the confidence and trust within financial markets as we learned in 2008.

Hobson: Now then let me ask you about something that Jamie Dimon, the CEO of JP Morgan Chase, said this morning on CNBC. He said that if there is a messy default in Greece, that U.S. banks will not be hurt at all.

Laurenti: That seems to be a little bit too optimistic, and also minimalist. Yes, it's true, we don't have too much direct exposure to Greece. But we have a lot of exposure to the French, and German, and many other European banks -- who are heavily exposed to Greece. So the chain and the risk is there, even if Greece in itself is not that big for the U.S. financial markets.

Hobson: Adolfo Laurenti, deputy chief economist with Mesirow Financial, thanks so much.

Laurenti: Thank you, my pleasure. Bye bye.

About the author

Jeremy Hobson is host of Marketplace Morning Report, where he looks at business news from a global perspective to prepare listeners for the day ahead.

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