European Disaster Scenario: No Good Way to Hedge

By Tom
Updated on

European Disaster Scenario: No Good Way to Hedge

In reference to this earlier article which stated  in regards to the Greek failure:

The banks gross positions on Greece in Credit Default Swaps was (if I recall correctly) 70 bio. EUR, but the net position was 3-4 bio. EUR. For the European banks I saw.

If I’m not mistaken this was the tool the ECB used to bring about a “voluntary” haircut from investors!

What was done was to let the investors and banks remain in doubt as to the definition of a “credit event”.

Scenario A was letting Greece go bankrupt – which indubitably would constitute a credit event. This would call for payment according to the CDS terms. As the banks had insured themselves crisscross then in theory the payments should even themselves out. But in practice it would mean that if only one of them was not able to meet their commitment, then all the others would not get paid by the asymmetrically exposed participant in the musical chair dance – and as such the OTHERS were not able meet THEIR commitments.

Scenario B was: Forget about bankruptcy – All creditors accept a haircut of 75%-90% (depending on the realism in valuation of the new bonds they did receive) – and forget about their CDS and flush them in the toilet.

In scenario A there was a dead certain loss of 100% because eventually none of the CDS obligations could be honoured.

In scenario B the creditor might get a symbolic recovery of their investment.

Not surprisingly the creditors elected to “voluntarily” take at least a 75% loss.

In 2008 the USA was caught with their underwear in disarray and had to guarantee the credit insurance companies in the wake Lehman Brothers folding. That was not going to happen to the EU in the Greek case, so the ECB skillfully played the banks that thought they could play the ECB and CB’s of Europe.

As it is these insurances rely on a flawed logic – and are just a Ponzi-scheme in the original and real sense of the word.

There are roughly two kinds of risk: The systematic and the unsystematic.

Unsystematic risk: An insurance company can insure a house against flooding IF these houses are spread all over the world. That will mean a regular average payout balanced by payment of regular premiums. You might make a profit on that.

Systematic  risk: When you concentrate all your insurances in a limited area and once in a long while there is a tsunami that will mean you have to pay out to all your clients simultaneously – which you obviously can’t. Until this event happens you are making money hand over fist – there are no outward bound payments. When the event happens you are dead and your insurance is a hoax.

Covering the risk of a default by a nation is – ipse facto – a systematic risk that cannot insure against. Your friendly snake-oil salesman of a Ponzi-scheme bank will tell you otherwise – he has bought insurance against the tsunami: He hasn’t as this is a risk that can’t be insured against, as all want to be insured against the same event at the same time. A CDS against Germany is a joke in bad taste: Either Germany honours her debt – and the buyer of the CDS has just wasted their money – Or Germany doesn’t pay, and if they don’t pay the insurance company can’t pay either.

CDS on sovereign bonds is a contradiction in terms.

People selling them are deeply dishonest because either they know they are selling a Ponzi-scheme or so stupid that they are into things they haven’t got the remotest idea about. A CDS on a nation is an intention to defraud.

Why do you think the EU (Germany in particular) want a Tobin-tax?  They want to eliminate the banking snake oil salesmen. But then the jobs and the trade will disappear from the European banking system the banks whine.

Of course it will! That is the intension!

Now I don’t know if there will be a Tobin-tax or not; but Wolfgang Schäuble has made it perfectly clear, that he wants these Ponzi-schemes closed down one way or the other. When a German Finance Minister starts pounding the table like that it is high time to start running. He has the might of the Bundesbank – and the ECB – behind him, and he will make sure banks will be hurt. In the Greek case the banks got off easy, but chances are that next time the outcome will be even uglier – for the banks.

Leave a Comment