Here Is Why Greece's 12 Year Reopening Earlier Was A Failure

Tyler Durden's picture

Call it poetic justice. In its pursuit to kill CDS "speculators", Greece has shot itself in the foot, and potentially hit a major artery. Earlier today Greece tried to do a quick drive by with a €1 billion in a reopening of a 12 Year auction. Instead, it barely managed to get €390 million off: a miss by 61%, which anywhere else would have caused the organizers to scrap the auction and never mention it again (but not here). The lack of demand for the remarkably stupid surprise auction, orchestrated by former Goldmanite Petros Christodoulou, achieved no incremental funding for Greece but merely spooked the entire curve, and forced buyers of yesterday's 7 Year auction to take immediate losses, as the bond traded down from 6% to 6.27% (not to mention a move wider in CDS). This is the third sequential auction in which primary buyers have taken post break losses. At this rate of disappointment (yesterday the 7 Year had a meager 1.4 Bid To Cover ratio), soon Greece will be unable to pull anything issuance off. Yet the bigger reason for the lack of demand is even simpler: the hounding of all those who hedge exposure with CDS. It doesn't matter if one has naked or hedged positions - any purchase of Greek protection is enough to get the European secret services scouring through your garbage. And this is precisely what Zero Hedge and many others have been warning about for weeks. And just in case we might not have been clear enough, here is Deutsche Bank explaining once again, just how negative for primary issuance and for sovereign borrowers, the escalation in the anti-CDS rhetoric is.

Speculators are said to have been involved in the escalation of the Greek crisis. For this reason, politicians want to ban the purchase of naked credit default swaps (CDSs). This would not be of any help to sovereign borrowers, however.

A financial-market segment hitherto considered exotic has received broad attention in the last few weeks. There has been intense debate among politicians and the media on a ban on credit default swaps (CDSs). These derivatives which were invented, inter alia, to insure credit risks are said to have been used by speculators and thought to have been among the major factors for the increase in the risk premium on Greek government bonds. Criticism has focused on the purchase of derivative hedging instruments without the CDS buyer actually owning the bonds to be insured.

At first glance, it may indeed be difficult to recognise an economic benefit in these transactions. It is even harder to see any advantages on the basis of critics’ analogies. Their rationale is that the purchase of a CDS without the buyer actually having an insurable interest is like buying fire insurance on a neighbour’s house. The insured would benefit from the misfortune of his neighbour or, even worse, would be tempted to burn down the house.

As illustrative as the comparison may be, it conceals the actual function of derivatives markets. Credit derivatives are a different story and much more than the insurance policies desribed above. They are instruments which allow market players to trade risks and rate them on a daily basis. CDS contracts are a hedging instrument not only against the default of a borrower but also against temporary fluctuations in the rating of his debt service capacity.

Banks enter into CDS contracts for hedging credit or counterparty exposure and reducing concentration risks in their portfolios. Institutional investors enter into CDS contracts to hedge their investments and gain access to credit risks, which allows for a better risk diversification in the portfolio. Supervisory authorities and central banks as well revert to price signals of the CDS market to assess default risks in the financial system.

Better hedging possibilities for creditors indirectly also benefit borrowers. In the case of Greece, mainly banks and other bond creditors used CDSs to hedge against a deterioration in debt sustainability and thus a price decline of Greek bonds. Without this possibility, many investors – in view of the rapidly deteriorating situation – would have abstained from buying further Greek bonds or even reduced existing positions. Here, CDSs have contributed to a stabilisation of the situation, not a deterioration.

The positive effect was not limited to sovereign borrowers, though. Rather, CDSs on Greek government debt helped to hedge credits to Greek companies and financial investments for which no instruments exist. Here, CDS buyers had a genuine and legitimate hedging interest although they did not hold any Greek government debt themselves.

Against this background, a ban on naked CDSs as currently called for by many EU politicians would be counterproductive. Any CDS seller would be forced to find a buyer who is able to prove a hedging interest. Besides the difficulty to impose a uniform ban across all jurisdictions, such a measure would be associated with a considerable reduction of the liquidity and efficiency of the market. This would affect especially those who have an insurable interest. It would be harder for them to find a counterparty and they would have to accept higher costs.

The question remains to be answered how to handle purely speculative trades which are not directly related to a hedging interest. Here, a distinction has to be made between speculation in a narrower sense and market manipulation. While speculation no doubt has an economic function, market manipulation is forbidden and should be punished. In our picture: whoever burns down the house of a neighbour, has to be aware of the fact that he will be prosecuted. Incidentally, the German financial supervisor BaFin stated recently that it could not see any indications of such manipulation in the CDS market.

BaFin shares the view that risk premia on Greek government bonds were dominated by concerns about Greece’s debt sustainability, a credibility problem and uncertainties surrounding future political measures on EU and domestic levels in the last few months. Rising CDS premia were attributable to increasing hedging requirements and not to speculation. In other words, the reason for difficulties in the refinancing of the Greek deficit are doubts about its future financing capacity – doubts which would also exist without a CDS market whose prices are a reflection of the problem and not the cause of it.

A ban on naked CDSs would have the effect of unilaterally curtailing the market. Thus, it would still be possible to bet on rising prices but a corrective force against exaggerations would be lost. Investors would be prevented from speculating against a trend and building up corresponding positions. This, however, provides the market with liquidity and ensures that prices cannot move away from reality completely. Finally, a ban on naked CDSs would not prevent the required market corrections because the sale of underlying securities would still remain an option. In a best-case scenario, upcoming market reactions would merely be delayed. As soon as they emerge, they could be all the heftier, however. In the meantime, speculators could opt for other instruments instead.

With or without speculators, markets do not function without frictions. And in segments where weaknesses are apparent a solid framework is required. Already before the financial crisis, such weaknesses in the CDS market were apparent in the areas of transparency and market infrastructure. The efforts made since then – which have been strengthened since the outbreak of the crisis – by private and sovereign agents to eliminate these weaknesses reflect that the problems have been identified and addressed already. In their own business interest, market participants are keen on a reduction of operational risks and an increase in systemic stability. Here, a flanking of the initiated measures by the supervisory authorities would make sense. Emotionalising the debate and demonising certain trades would not solve the problem, however.

In the meantime the speculators, knowing full well they are not welcome, are logically leaving: gross notional CDS on Greece declined by 10% over the prior week: from $77 billion to $70 billion per DTCC. When this number (and the net) hits zero, we can guarantee Greece it will be unable to issue any more sovereign debt, with or without an implicit or explicit guarantee by the IMF, Cosa Nostra, EU, CIA, Triads, KGB, Mossad, the Fed, and Goldman Sachs (in order of nail extracting efficiency).

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knukles's picture

Well, accuse the folks in capital markets of being thieves, threaten retribution when they just do their jobs, and sooner or later, they'll believe your screed.  

They'll act like you expect them to, and you'll pay more.


God Bless John Wayne.

williambanzai7's picture

This is truly a Faustian bargain.

The CDS market provides the liquidity necessary to  satiate the cash appetite of a basket case like Greece. Liquidity that in a moment's notice can vanish and send the whole edifice crashing.

Is it better to have a less liquid market with punitive debt origination costs for undisciplined  borrowers like the PIIGS and California? Isn't a reduction in access to debt capital for Greece a better outcome? That is what appears to have happened as a result of the CDS witch hunt.

boooyaaaah's picture


This really is a problem.
You have to find a buyer.
Same with naked short selling --- forced to find a borrow before you sell.

The problem has been with us for centuries. Selling something you don't own is so much more convenient.
The Brooklyn bridge for example.
Kings could do it.
Just printing money for the good of the peasants.
Unbalanced scales in the ancient market place sure increases needed sales.
And everyone needs sales.
Yes and so what if the Greeks are crooks --- the object now is to help them.
And the best mosst convenient way to help a crook is to hire a crook.

A Man without Qualities's picture

It is almost as though Greece is trying to push the market against them so they can say that unless they get a direct loan from the other EU member states, at the rate they borrow, the interest expense alone will kill them.

The other member states need to wise up and stop assuming the Greeks have changed their ways - they are still trying to game the system, in my view.

Mr.Kowalski's picture

Now that is how to muck up an auction !! IMF by the Ides of May I'll wager. Surely the Greeks must know The End is near.. and they're right. The real party starts when IMF money is burned thru by year's end.

Mr.Kowalski's picture

WilliamBonzai: "Isn't a reduction in access to debt capital for Greece a better outcome?"

Better than 3/4ths of Greek debt is owed to foreigners.. if they refuse to lend and the Greek economy crashes, whats to stop Greece from simply defaulting on a few hundred billion in debt, triggering another 70 billion in CDS', and watching their own banks (and their foreign debts) crumble, and setting off a crisis in EUtopia ??


williambanzai7's picture

Sounds like the club AIG should have waved at its counterparties in 2008.

ZimbabweBen1991's picture

Are you drowning in deficit and is you cannot pay your entitlement programs?  Are you facing riots in your streets and blame CDS speculators for your own stupid spending and borrowing habits? Are you tired of austerity cuts?Well have no fear call 1-888-IMF-CASH to get a bailout oh I mean "loan" to fix all your problems! We at IMF CASH have given cash to needy nations in Africa and that has worked fine and we helped Iceland too. At IMF our goal is to give you money to continue spending like drunken sailors. You have unfunded gov't pensions? Paid. Got deficits above 12%of GDP? Balanced budget. So call 1-888-IMF-CASH. That 1-888-IMF-CASH! Call now you will get a second package with nostrins attached. At IMF CASH we have a great history helping third world nations get of their feet. Call now and get your nation back on track!  Results may vary

williambanzai7's picture

Do I have your permission to turn this idea into a cartoon? :-)

Results may vary...


ZimbabweBen1991's picture

sure you can do a cartoon on IMF CASH. no patents here lol.

carbonmutant's picture

What a way to start the morning...

ZackAttack's picture

Funny how governments are allowed to control the language of the debate... if it happens somewhere else, they're "bond vigilantes" serving a useful purpose of policing runaway deficits. But if it happens to you, they're "evil speculators" denying you access to the credit markets.

jedwards's picture

I thought they learned the first time that the Easter Bunny is not their friend... he's shorting the fuck out of Greek bonds!

john_connor's picture


Does this kick off the shitstorm on the Titus SPV?

LONDON (MarketWatch) -- Moody's Investors Service cut the ratings of five of the nine Greek banks it covers -- National Bank of Greece /quotes/comstock/13*!nbg/quotes/nls/nbg (NBG 4.04, -0.07, -1.70%) , EFG Eurobank Ergasias, Alpha Bank, Piraeus Bank and Emporiki Bank of Greece -- and said the outlook on all five lenders is negative. "Rating actions were prompted by the country's weakening macroeconomic outlook and its expected impact on these banks' asset quality and earnings-generating capacity. Pressures on the macroeconomic fundamentals have been evident for the past year and are expected to intensify as the year unfolds," the rating agency said.

Leo Kolivakis's picture

Thank those good folks at DB for explaining to all of us the virtues of CDS, and showing Greece that "we got you by the balls".

carbonmutant's picture

"A trap is always preceded by one's own choice of entrance."

TheMacroView's picture

This has only highlighted that the "pledge of aid" by Europe to Greece is a load of crap. Germany knows it, and now its become very clear that the market knows it too.

The Macro View


ZackAttack's picture

Greece (and formerly, Germany, right?) selling those $USD-denominated bonds has to be the ultimate contrary indicator.

jm's picture

I've been discussing this issue of inverted CDS curves with Professor Pinch at his blog: 

As soon as a sovereign CDS curve inverts, the entity should immediately default.

Experience showing that the only thing to be gained from dickering around further is an interest burden that reflect de facto default anyway, no?

asteroids's picture

OPA! I hear dishes breaking everywhere.

Return2Sanity's picture

Serial Arsonist: I need you to loan me some money to buy a new asking what happened to the first five houses I bought...and no buying fire insurance behind my back...hello...anyone there? Why are you all running away from me?

1fortheroad's picture

And here I was wondering why the EUR/USD was up this am. Boo-yah

jippie's picture

I agree with your view that CDS traders can't be blamed for Greece's crisis and many other things. But the DB article is not as convinicng as you make it sound.

It doesn't talk at all bout the providers of CDS, and their interest. Let's assume for simplicity there is a fixed number of suppliers (sellers of CDS). If we ban naked CDS that means there is less demand for CDS. This will lower prices for people with real insurable interest! The complete opposite of what you highlighted as bold in the text above:

Against this background, a ban on naked CDSs as currently called for by many EU politicians would be counterproductive. Any CDS seller would be forced to find a buyer who is able to prove a hedging interest. Besides the difficulty to impose a uniform ban across all jurisdictions, such a measure would be associated with a considerable reduction of the liquidity and efficiency of the market. This would affect especially those who have an insurable interest. It would be harder for them to find a counterparty and they would have to accept higher costs.

That sounds liek complete BS. Similar to the arguments put forward in the case for HFT trading.

It get's frustrating to hear the arguments for any financial instrument (or "innovation") to be labelled as making everything more efficient. That argument completely ignores the increased systemic risks introduced by higher complexity, interconnectivity and self-reinforcing behaviours. There is a reason why we put up Street lights, and Stop signs in cities. To make it less efficient, but avoid excessive risks!

It seems strange that zerohedge puts articles like the Rickards interview ( Or the various Taleb pieces. Yet at the same time promotes articles like the one above which may be right in this particular instance but obscure the fact that overall CDS markets are not needed. We will live happyily without them, without increased systemic risks. Overall Financial services are rent-seekers that should facilitate transactions. The fact that they capture 40% of profits (in the US) is a sad fact that the rewards for risk taking are not going to the people actually taking the risk (i.e. setting up business, inventing things, sacrificing consumption, etc.). All these derivatives in the end do is capture more rent for financial intermediaries. Yes tehy enhance "efficiency" in most cases, but at what cost?!

One should always remember to asses the counterfactual. Would we really be worse off not having all these efficiency introducing derivatives? Go back in history and compare?!


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