Greek Crisis Raises New Fears Over Credit-Default Swaps!

• CDS (Credit Default Swap) are financial derivatives contracts. They are essentially insurance against debtor default ie. an insurance policy. However, unlike the insurance industry, the financial derivatives market is essentially unregulated. It is more accurate to characterize the market as a financial casino. Anyone can buy a CDS (ie. place a bet) to insure themselves say for US$1B against a default by Greece, even though they are not holding any Greek debts/bonds. Of course, the buyer of the CDS is betting that Greece will default. This is termed as a naked CDS! It is financial madness and makes Las Vegas look like Sunday School.
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  Greek Crisis Raises New Fears Over Credit-Default Swaps! 
  By PETER EAVIS, http://www.nytimes.com/ 
  Greece’s debt restructuring is dragging credit-default swaps back into the spotlight. The last time this financial instrument was on the global stage was in 2008, when the American International Group’s credit-default swaps brought the insurer, as well as the wider financial system, to the brink of collapse. A.I.G. had unique weaknesses, and regulators have started to overhaul the credit-default swap market since 2008.
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  European policy makers have nonetheless looked warily at credit-default swaps, at least until recently, while they structured the Greek rescue over the last six months. They aimed for a voluntary debt exchange that would not initiate the default swaps, fearing that payments on the swaps might set off destabilizing chain reactions through Europe’s financial system.
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  But now, with Europe’s $172 billion aid package for Greece, it appears that the nation is going to take a step that substantially increases the likelihood that its swaps take effect.
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  To get maximum debt relief, Greece needs to have as many qualifying bonds as possible join the restructuring. Toward that end, Greece may insert something called a collective action clause into bonds issued under Greek law. If the clause is inserted and then invoked, all bondholders will be forced to take a haircut, making the exchange involuntary. That would set off the default swaps.
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  The official decision on whether a default swap has been activated is made by the International Swaps and Derivatives Association, an industry body.
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  “I have very little doubt that they will be triggered,” said Darrell Duffie, professor of finance at Stanford.
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  … for more click here!

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