Banks gamble on the future of Greece

Marketplace Staff Feb 25, 2010

Banks gamble on the future of Greece

Marketplace Staff Feb 25, 2010


Bob Moon: What would you call it if I told you that those never-miss-a-trick wizards of the financial world are at it again? This time, the New York Times reports banks are placing big bets against the financial future of Greece. The very same banks that loaned Greece billions are now betting the country won’t be able to pay the bill. The story points out that it was this same kind of betting using something called “credit default swaps” that ended up pushing the global insurance giant AIG into financial collapse. Here’s what Fed boss Ben Bernanke had to call this on Capitol Hill today.

BEN Bernanke: Obviously, using these instruments in a way that potentially destabilizes a company or a country is counterproductive.

“Counterproductive,” because, all this betting against Greece is making its financial struggles even worse. Felix Salmon is a finance blogger for Reuters, and he’s here to help us understand how this big gamble is playing out.

FELIX SALMON: A pleasure.

Moon: So Mr. Bernanke says “counterproductive.” Is that an understatement or not? How serious is this?

SALMON: It’s not that serious yet. At the moment it’s not clear that the credit default swap market is making matters worse. And in fact, I suspect that at the margin it might even be giving Greece access to the markets which it wouldn’t otherwise have, and it might actually be a good thing.

Moon: OK, so help explain this if you will. What is going on here? At first we heard that Goldman Sachs and other banks were helping Greece hide its debt. Now we’re hearing that they’re betting against that very Greek debt.

SALMON: In the first instance, what happened back in 2001 is that Greece wanted to make its debt levels look better than they actually were, and to do some of what you said, hiding their debt. And they hired Goldman Sachs to help them do this with a currency swap. Now that everyone has found out about the currency swaps. Well, we knew about the currency swaps as long ago as 2003, but nobody was particularly worried about them back then. People got worried a few months ago when they discovered just how big the Greek national debt was. Goldman itself doesn’t have a huge amount of Greek exposure but a lot of European banks do. And so the great thing about the credit default swap market is that the European banks can hedge that exposure by buying insurance essentially on Greece defaulting and once they’ve done that they can hold onto their debts because they’re hedged.

Moon: What about the quote in the Times, though, about this being like buying fire insurance on your neighbor’s house?

SALMON: Well, it is like that if you don’t own the debt to begin with. But the people who are buying these credit default swaps in bulk are the big European banks who have lent money to Greece, so in fact they’re more like buying insurance on their own house. They’re doing the responsible thing.

Moon: Or it’s as if you helped finance your neighbor’s house and when you see your neighbor having a little problem then you decide to take out a little insurance.

SALMON: Exactly.

Moon: So what’s the problem here?

SALMON: If the credit swap default market makes look Greece much riskier then that can increase the price Greece has to pay to borrow money. On the other hand, if the credit default swap market didn’t exist at all then there’s a very good chance that Greece couldn’t borrow money at any price and that would be a real crisis.

Moon: Do you think it’s notable that the only bank that Mr. Bernanke mentioned today by name was Goldman Sachs?

SALMON: Absolutely. It’s very, very easy to demonize Goldman Sachs. I don’t think we should consider this to be anything indicating Goldman Sachs is uniquely evil. Every bank was selling these currency swaps to Greece and Italy and other countries back in the early parts of the last decade. And every bank is trading credit default swaps as well. Goldman Sachs is not unique in this.

Moon: So where is this all headed? Do we run the risk of this piling on factor of Greece not being able to service its debt?

SALMON: There’s always that risk. And there’s always the risk it will spill over into other highly indebted southern European countries as well, like Spain and Italy and Portugal. On the other hand, if the liquid credit default swap market gives people the ability to hedge their bets much better than if it hadn’t existed then maybe the existence of the market will mean that Greece can continue to borrow through this current crisis and can get through the other side and will avoid the kind of extreme fiscal crisis that would be a consequence of not being able to borrow at all.

Moon: Your argument is it makes them be more responsible.

SALMON: Yes, it does.

Moon: Felix Salmon is finance blogger for Reuters. Thank you for joining us.

SALMON: It’s a pleasure.

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