The modern independent central bank was born in New Zealand in 1989. It had a short life. The onset of the financial crisis of the north Atlantic region in August 2007 signalled the beginning of the end. Today, only the ECB still has a significant degree of operational independence left, and it will have to give that up if it is to be effective in the current phase of the crisis. In other words, the ECB is the last central bank to understand that, if it is to play a significant financial stability role, it cannot retain the degree of operational independence it was granted in the Treaty over monetary policy in the pursuit of price stability.
CDS in Kazakhstan
A fascinating contribution by Gillian Tett in today’s Financial Times on the role of CDS in the default of the largest Kazakh bank, BTA, raises a number of wider issues. Last week, BTA went into partial default when Morgan Stanley and another bank demanded repayment of loans they had made to BTA and BTA was unable to comply. Tett also discovered that, just after calling in its loan to BTA, Morgan Stanley asked the International Swaps and Derivatives Association (ISDA) to start formal proceedings to settle credit default swaps contracts written on BTA. I don’t know the aggregate value of the credit default swap contracts written on BTA that Morgan Stanley owned, whether it was smaller or larger than the value of the loans to BTA called by Morgan Stanley, or who the writer(s) of these CDS contracts was or were. But it raises concerns.
The reason it raises concerns can be made clear with the following hypothetical example. Assume some large western bank, let’s call it St. Manley Organ Bank, has made a loan of size A to BTA or has bought its debt in amount A. As a creditor to BTA, St. Manley Organ would normally want to avoid a default by BTA, because St. Manley Organ is bound not to get paid in full in the event of a default by BTA.