Last week Bernanke said they would investigate their use in the Greek crisis. This morning Munchau, pens an article calling for their outlawing.
I generally do not like to propose bans. But I cannot understand why we are still allowing the trade in credit default swaps without ownership of the underlying securities. Especially in the eurozone, currently subject to a series of speculative attacks, a generalised ban on so-called naked CDSs should be a no-brainer.
Naked CDSs are the instrument of choice for those who take large bets against European governments, most recently in Greece. Ben Bernanke, the chairman of the Federal Reserve, said last week that the Fed was investigating “a number of questions relating to Goldman Sachs and other companies in their derivatives arrangements with Greece”. Using CDSs to destabilise a government was “counter-productive”, he said. Unfortunately, it is legal.
Greece CDS is quoted at 350 bips this morning and accusing fingers are pointing to hedge funds. So it seems Paulson and GS went one CDS too far by shorting government debt and are now attracting the political ire of regulators.
I find the article doesn't go far enough in analysis and just skims the reasons why they are nefarious. The biggest one being that when a CDS triggers they are a liquidity drain. You have to come up with a cash settlement for large sums of money. I remain convinced that the panic of aug 2007 can be directly linked to a liquidity drain triggered by naked CDS on subprime. There was a 4:1 naked to non-naked ratio...
Of note, Goldman Sachs (GS) and many others were in the business of selling the short side of these securities to speculators (and themselves) and marketing the long side to investors with AAA ratings. "Abacus", for example, was built from naked CDS. When subprime blew up those CDS blew up and with a lever of 4:1. AIG was at the end of the line, meaning the government... Ouch... GS will be investigated in conjunction with AIG and these securities is my guess.
In the meantime, I feel rather good about myself. It just makes me feel good to know I was on the right track in analyzing the mess. Go me.