Fisher Investments Editorial Staff

A Tale of Two Swaps

By, 03/11/2010

Story Highlights:

  • Greek cross currency swaps and credit default swaps have been in headlines lately.
  • Some feel these swaps exacerbated current Greece debt woes.
  • Greek debt troubles are neither new nor secret. 
  •  Arbitrarily banning certain investment vehicles usually doesn't reduce risk or erase crises already underway.


It seems we're heading towards an age of foolishness—as politicians blame speculators for, well, speculating. Legally, one might add. In this case, the hullabaloo surrounds Greek cross currency swaps and credit default swaps (CDS). Let's unravel the two issues a bit here.  

Issue #1: Goldman Sachs is taking a lot of flak for engineering a Greek cross currency swap, completed prior to the country entering the European Union (EU) in 2001. Then Goldman later began issuing sovereign CDSes too. Many view this as a conflict of interest—on the one hand, Goldman has specific information on Greece's finances and, on the other, they're selling insurance on those finances. And now folks accuse Greece (with Goldman's help) of "obscuring" its true debt load. Did it? Yes, frankly, a bit. But nothing close to enough to materially impact the total amount of debt outstanding (CDSes make up only about 3% of the government's total debt).

And though demonized, currency swaps are as normal as apple pie (or baklava) and completely legal in both government and private financing—have been for years. Further, the swaps are between willing parties and are usually mutually beneficial (i.e., swapping comparative advantages). And note, even after entering the EU, Greece has complied with the euro zone's debt criteria only once in the past 20 years—though the exact details may have been partially obscured, Greek debt troubles in general are neither new nor secret.

Issue #2: More on CDSes, an entirely different kind of "swap." Politicians are blaming credit default swap "speculators," namely, those trading "naked" CDSes—when the buyer has no risk exposure to the underlying equity—for worsening Greece's credit conditions. Historically, CDSes are traded primarily "over the counter"—firm to firm—not on a public exchange. Leading the charge against Greek CDSes is Greek Prime Minister George Papandreou. In one sense, he's right—both currency swap and credit default swap markets would benefit from more transparency. Transparency only helps with price discovery and making markets orderly. But, at the same time, the Greek PM is under fire and it's a smart political move to shift some blame to faceless "speculators" (or, what some might call investors). Said another way: Speculating isn't a crime. In fact, they can be useful in showing the market where problem areas are (or may be.)

Greece could ban CDS trading tomorrow, and it would still have a debt crisis. In fact, they could have banned it five years ago, and it likely wouldn't have impacted their current situation much. Not only that, but the total outstanding Greek CDSes is about $9 billion notional—not nearly enough to control pricing on $400 billion of Greek debt overall. So more transparency? Yes, definitely. Banning? Doesn't solve the problem folks hope it does.

In crises, it's natural to want to find a scapegoat. But it's almost never as simple as saying "If only XYZ hadn't existed, we wouldn't be in this tight spot." And often, in the case of swaps and other derivatives, if XYZ didn't exist, we might not even know we were in a tight spot until it was too late.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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