European Commission To Back CDS Trading Ban As Second Round Of Strikes Cripples Greece; Greek GDP Now Expected To Miss Worst Case Scenario

The Washington Post reports that the next "Lehman-sized" event may be just around the corner, as the European Commission is now supporting a ban on trading sovereign CDS. While we are in process of tracking down whether this is actual news or just some exaggeration based on semantics, we will caution, once again, that the consequences of a CDS trading ban will be severe and very likely result in the opposite of what the EC intends on achieving. Keep in mind that everyone expected the Lehman bankruptcy to be contained as it was at best a fringe cog in the financial system. The result was a systemic collapse as one interlinked component of the financial fabric imploded after another. The rush to unwind CDS positions ahead of a ban will be massive and have unpredictable consequences. But the biggest threat is what happens to bond prices, which once basis trades are made impossible, will be promptly unwound, leading to pervasive selling of the cash leg not by speculators but by plain vanilla mutual fund idiot money. What scapegoaters seem to forget is that the vast majority of existing sovereign CDS notional is tied into perfectly boring insurance "basis" trades, in which the bond is held in combination with associated CDS. Once there is an inability to have hedged cash sovereign exposure, the demand for European sovereign paper will plummet, achieving precisely the opposite of what the CDS ban is attempting to accomplish.

According to the WaPo:

The European Commission said it would back a proposal to restrict trading in a type of financial instrument, known as a credit default swap, that is linked to the prices of government and corporate debt... "Europe and America must say 'enough is enough' to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system," he said. "An ongoing euro crisis could cause a domino effect, driving up borrowing costs for other countries with large deficits and causing volatility in bond and currency rates across the world."

And far away from financial innovation land, Reuters reports that an approaching hurricane of another round of paralyzing general strikes is about to lead to a drop in Greek GDP that will be worse than even worst-case prior expectations, leaving the rating agencies to scratch their heads what excuse they can use this time to avoid downgrading a flailing Greece:

The Greek economy is set to shrink by more than expected this year, the government said on Wednesday, as it braced for nationwide strikes protesting its plans for bringing the country's budget deficit under control. Greece, grappling with a ballooning deficit and a 300 billion euro (272 billion pound) debt pile, told the European Union that 2010 gross domestic product (GDP) would "most likely" shrink by more than the 0.3 percent currently forecast. It also said the drop may exceed an alternative, more pessimistic, scenario published in Greece's Stability and Growth Programme in January envisaging a 0.8 percent contraction. Economists and ratings agencies have warned that a sharper than expected slowdown in the economy is one of the biggest threats to Greece's commitment to cut its budget deficit to 2.8 percent of GDP by 2012 from close to 13 percent last year.

So even as ECB is preparing to launch its own rating agency so it can avoid the risk that Moody's grows a consciences and rates Greece at or about the proper rating of CCC-, just so Greece can pledge its bonds as collateral in perpetuity regardless of how sever its default will ultimately be, it will be tough to place the blame for the next massive round of Greek strikes on CDS traders. And massive it will be. The BBC reports:

Greece is expected to grind to a halt for the second time in a month as hundreds of thousands of state and private workers stage a general strike. The stoppage is in protest at the country's austerity measures. More groups of workers are staging industrial action and officers from the police, fire and customs services are planning to join the street protests. Greece's links to the outside world have been severed. Air traffic controllers have closed the country's airspace for 24 hours and ferries are stuck in harbours as maritime unions join the strike.

The amount of economic output loss daily will be staggering and will have ramifications for 2011 GDP which will certainly come double digits lower than presented in whatever rosy forecasts Greece may have shown to Trichet.

And instead of focusing on how to avoid what may ultimately culminate in civil war, Europe's fringe countries continue to be caught up in a ridiculous scapegoating and smear campaign that has no basis in reality, and which if pursued through execution, will result in an escalation of economic adversity and lead to yet another Ice-9 event. But that's what politicians do: they scapegoat. And when one crawls to the very top of the blame-game pyramid, and hits the biggest problem of all - US debt, it will be precisely the same. As Jonathan Weil puts it in his latest brilliant missive: "Someday, should the rest of the world ever begin to question the U.S. government’s creditworthiness, don’t be surprised if the geniuses running our financial system find a way to blame short sellers and speculators for that, too."

One lesson government officials and CEOs alike should have learned is that they only undermine market confidence when they try to deflect attention from their own organizations’ failings by making preposterous claims or blaming trumped-up bogeymen. That some of them keep reaching for the same tired playbook speaks to their capacity for deluding themselves into thinking that others will believe them when they say ridiculous things.

As Weil so well observes: "This [scapegoating] has a certain mid-2008 ring to it. Back then, in the months between the U.S. rescues of Bear Stearns Cos. and the government-backed mortgage financiers Fannie Mae and Freddie Mac, the talk from Wall Street kingpins and regulators was much the same." Are we headed for another systemic failure, only this time with the US already tapped out, our only hope will be for Mars to come and bail out the entire earth. The alternative: global debt repudiation as every country defaults and devalues its currency at the same time. What happens next, nobody knows.