Playing the Scapegoat Game: Greece and the European Commission

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When sailing a small boat every action and movement has more significant consequences than when sailing a large ship. The shape of the sails, how close you point to the wind, where and how you shift your weight can all add or subtract a significant numbers of knots.

A small economy is equally sensitive to the actions of its tenders as countries seen as fiscally responsible by the marketplace enjoy relatively cheaper financing than those deemed profligate. For evidence of this we need look no further than Greece which has had the unfortunate opportunity to have its financial woes covered in the press with the same intensity as the paparazzi report on every aspect of Lindsay Lohan’s life.

The press and the paps are out to sell papers and pictures and the rule of thumb is usually, the more scandalous the better. I’ll leave you to your own devices concerning Ms. Lohan but regarding the Amerikani, the colloquial name given to Greek Prime Minister George Papandreou in light of his years spent in the U.S., the scandal is one he purports to be a victim of opposed to one he perpetrated.

In defense of his small southern European nation, he even traveled to meet with the new global leader of populist causes, President Barack Obama, to try to put an end to the trading of Credit Default Swaps (CDS) on his Hellenic habitué, specifically, and all sovereigns if possible.

The European Commission, which was complicit in allowing certain of the parameters for entry into the European Union to be overlooked to allow Greece to gain entry, jumped on the bandwagon as well with calls to ban “speculative” trading of CDS.

These efforts are very similar to those seen in the U.S. during the last 2½ years as Congress paraded more proposed culprits in front of various committees and commissions in hopes of finding an appropriate poster child for the credit crisis.

Never expecting, in that process, that congress would point the finger at itself, we were not surprised that George Papandreou and the European Commission followed a similar tack in only pointing fingers outward.

The real issue here is not the behavior of politicians but that the much maligned CDS market, including those that “speculate” using these swaps, represent reality and as such are a much needed instrument by which the markets help to keep in line those who live by both P&L and votes.

When federal spending in the U.S. grew to what the market believed were unsustainable levels in the early ‘90s, the “bond vigilantes” drove the rate on the 10-year Treasury to a little over 8.0%. There were, no doubt, speculators who sold Treasuries they did not own during that period but the result, a more fiscally responsible government (at least temporarily), was proof positive that the market’s voice is the one that should be heard.

To the extent that one would proffer the argument that the fact that CDS contracts are derivative securities vs. Treasuries which are bought and sold in the cash market makes them that much more culpable, I would raise the point that the net notional amount of CDS on Greek sovereign debt is about €9BN vs. €300BN worth of Icarian I.O.U.s, according to BNP Paribas. So, at just 0.3%, the argument that the tail is wagging the dog holds about as much water as a cracked cistern.

That the German regulator, Baffin, studied the situation and found no evidence of mass speculation on Greek CDS should be evaluated within the context that Germany would probably be among the first in line as a provider of assistance should things go really wrong in Greece and as such, could not be blamed for looking for a scapegoat itself.

It is a well known and oft proven fact that markets abhor uncertainty and their reaction to an increase in risk is to demand an increase in reward. Given this relationship and although it might be hard for some to fathom, the CDS market has actually helped Greece to the extent that by allowing the market to find its risk/reward equilibrium, the latest auction of the nation's sovereign debt was oversubscribed.

During this latest chapter in the credit crisis the Greek Prime Minister said, “We would like to borrow at more normal rates, or lower rates.” At 6.25% for the most recent issue, about 3% above where Germany can access the capital markets, that is certainly something to aspire to. As in the days of the Bond Vigilantes however, the markets are going to need to see fiscal policies more in line with Germany’s before they lend Greece money at rates in line with Germany.

To quote from an unattributed piece on the Op/Ed page of last Wednesday’s WSJ,

“The bets against Greek solvency are the result, not the cause, of Greece’s debt problems. The way to turn speculators profits into losses is by reining in government and reviving private growth.”

Let’s just hope they’re not saying the same thing about the U.S. in a few years.

CDS spreads on Greece got as low as 280bps on Monday of last week, hit 301bps on Thursday and closed the week at 291bps. During the height of the country’s most recent debt debacle, levels as high as 428bs were seen. The 35% reduction in insuring against Hellenic havoc is significant but must be measured against the lows of 100bps seen in early August of last year.

That 100bps level is interesting in that was the high point in insuring against a similar outcome in the U.S.A. in February of 2009.

Enjoy the week.