Politicians and Greek derivatives: why they should not interfere

Politicians across Europe and the US worrying about credit default swaps and the supposed speculative attack on Greece should put this article by Sam Jones at the top of their reading list.

Hedge funds stand accused of using CDS – which allow bets on the creditworthness of a country’s or company’s bonds – to undermine the Greek economy by sparking fear. I explained yesterday why this is nonsense, but Jones has dug into the data and found that the CDS are actually encouraging bond spreads to move tighter, thanks to what is known as “negative basis”.

Basically, the hedge funds that used CDS to short Greece over the past year or two are now covering their positions, writing insurance for other people who are worried about their exposure to Greece, particularly banks. As a result, if anything, hedge funds are actually helping keep Greek bond yields lower than they otherwise would be (although I suspect the effect is tiny, just as the shorting had little, if any, effect – the bond market is far far bigger).

This should be essential reading for Christine Lagarde, French finance minister, Spanish politicians, and German and US regulators, before they rush into ill-considered new bans on the use of CDS to short. Apart from anything else, hedge funds would just use slightly less convenient methods, anyway.

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