The Evils of CDS-Not!

It was rather disappointing to see Mutti Merkel come out recently railing against the demon of credit derivatives as if they were the cause of Greece's plight. The trend seems to be to blame derivatives for all the evils of the financial and by extension fiscal world. It might make for good populist rhetoric, but it is completely beside the point in both determining the cause of the current crisis as well as being the lightning rod to avoid the next one.

As I have mentioned before, the real culprits in this charade are the Regulators and the big accounting firms that through FASB and GAAP have created byzantine accounting practices which remove clarity and often enough support the use of derivatives in a non-speculative but definitely dangerous fashion.

So Frau Merkel decides to rail against the use of Credit Derivatives and is joined by a plethora of luminaries.

Bundesbank President Axel Weber is thought-provoking claiming "Not everybody who buys protection has an underlying exposure. It's a very intransparent market". Imagine that there are people who take outright positions through CDS.

UK FSA Chairman Adair Turner chimes in that CDS, and naked CDS in particular need to be examined by policy makers. Being British I guess he might get a rise out of using the term "naked" but I doubt his understanding of CDS suffices for any serious examination.

EC President Jose Barroso also wants to "examine closely the relevance of banning purely speculative naked sales on CDS". Just how close do you want to get to the nakedness Jose? Speculative, naked, sales. Just for arguments sake every trade is speculative unless you have inside information....so banning speculation might not be such a good idea. Naked just means outright exposure.

Richard Portes, a professor of economics at London Business School said "Naked CDS serve no useful purpose and are dangerous". He goes on to say "They do not help significantly price discovery or liquidity". Well, he too likes "naked", and maybe he is confusing the use of CDS with plumbing for depths by the Royal Navy.

Every time an instrument of any sort trades, unless it is either an accident or fraud, it "discovers the price". The fact is that traders sense that Greece is in trouble and by trading "against" Greece they will either force it out of the Euro, OR force the European Union to step up and commit.

In fact that is the problem right now. There is still no clarity on a Federal Europe and it remains unclear as to how this problem in Greece, and maybe other countries will be solved and so in the meantime to divert the attention of the masses away from the real problem that Greece is a mess it is much easier to attack CDS.

So what does Papandreou do? He claims that "unprincipled speculators" threatened a new global financial crisis and that he would discuss this with Obama.

Unprincipled speculators?! What about unprincipled government officials who use Interest Rate Swaps to obfuscate the true state of Greece's finances in conjunction with the likes of Goldman Sachs and others whose only concern is profitability.

Nothing wrong with profitability, and someone like Goldman Sachs is generally more than clever enough to understand the letter of the law and use it to their advantage....

And you wonder why I think Self-Regulation is a joke.