Photo by Kiwi NZ


The Greek debt mess reveals the credit default swap game in all its glory. It’s a fight between the arsonists and the hostage-takers.

Recall that a credit default swap is a contract between a protection seller and a protection buyer. The buyer might be the holder of Greek debt, either a bank that loaned money, or a holder of a bond issued by Greece. The buyer is worried about whether Greece will pay in full, and wants to be paid off if it doesn’t. It pays premiums to a protection seller, who agrees to make good any loss on the debt if Greece defaults or doesn’t pay in full.

It’s easy to understand why a debtholder wants protection. The rationale of the protection seller is pure profit: you make money and you don’t have to pay unless there is a very unlikely event. In other words, the protection seller is just gambling. Of course, they try to explain it as a way to take a position on Greek debt with lower transaction costs, or some other equally preposterous story for the rubes, but it’s gambling. And the proof is that you don’t have to be a debtholder to buy protection. You can gamble on either side.

The metaphor is that gamblers buying protection when they don’t hold debt is like buying insurance on your neighbor’s house, giving you an incentive to turn arsonist. So, lets call one group of gamblers the arsonists. The protection sellers really don’t want to pay off. So they threaten that forcing them to pay off will destroy the financial system just like letting Lehman file bankruptcy did. Of course this battle takes place in the media, like this salvo from the hostage-takers, but it also goes on in whispers into the ears of captured regulators and suck-up congressionals. They pitch in on the side of policies that will hurt the Greeks and benefit the hostage-takers.

There are a lot of Greeks engaged in peaceful protests. The non-violent are working for themselves, but if they were successful, it would benefit the arsonists, those who want Greece to default. The anarchists and the violent distract from the legitimate complaint that Greece is being destroyed by the hostage-takers, those who benefit if Greece pays off in full. We don’t know who is behind the Greek anarchists and other violent protestors. Greece has a long tradition of violent street demonstrations. According to this and this, the government is behind the heavy-handed police response. But for sure, the hostage-takers are cheering them on, and hoping that the government will respond by insisting on paying off the debt in full, and turning Greece into the first corporatacracy.

This is hardly the first time the arsonists and the hostage-takers have fought it out in the news media, and behind the scenes with their friendly regulators and their purchased congresspeople. Look at AIG, where the hostage-takers talked their regulators into giving them hundreds of billions so they wouldn’t have to pay off.

As we speak, some people are betting against the US dollar using CDSs, and the price has been going up. Sure, it’s cheap today, about 50 basis points, but that is up from about 21 basis points in April. Someone has doubled their money very fast. What happens if enough insane politicians decide to vote against a hike in the debt ceiling? Who will profit? Who might be willing to stiffen the spine of a bunch of Tea Party nutcases with a few thousand in campaign contributions to multiply their money by holding the US hostage?

The weakling administration and the spineless democrats in Congress refused to regulate this industry, leaving in the hands of a captive regulatory structure. Just one example: the Fed succumbed to lobbying pressure from giant banks to keep their profits up at the expense of every consumer and every non-financial business with their cave-in on swipe fees. The corrupt Republicans and their Tea Party Zombies cheer on the Fed, knowing that their ignorant partisans don’t have a clue.

Not that having a clue makes a difference, it doesn’t. Obama and his bankster-loving advisers don’t care about policies to support middle class America. The only constituency that counts is money, and we don’t have enough to matter. Obama will see to it that we pay both sides, either directly by bailing them out, or indirectly by passing a destructive budget.

The Wall Streeters of both factions are laughing at us, all the way to the bank.