Some say Greece is wrong on derivatives
NEW YORK — Derivatives have become a dirty word. The complex financial products helped blow up the US housing market. They all but sank AIG. Now, European officials want to crack down on a derivative called a credit default swap. It’s an insurance-like product they say has worsened Europe’s debt crisis and could bankrupt Greece.
Hold on, many analysts say: Credit default swaps — contracts that insure debt — have actually prevented Greece’s debacle from worsening. Without them, they say, investors would be less willing to buy Greece’s debt. It would probably need a bailout.
“If we get to a point where we’ve had enough with credit default swaps, then I think Greece will have serious problems,’’ said Darrell Duffie, a finance professor at Stanford University.
Sellers of credit default swaps agree to pay the buyers if the debt goes bad. With swaps, investors who lend to countries by buying their bonds can reduce their risk. Without them, Duffie and others say, Greece’s borrowing costs would escalate; lenders would demand higher premiums.
Greece argues that traders of the swaps who bet against Greece’s debt are raising its borrowing costs, making default more likely. It claims trading of swaps — which is unregulated — is racking up big profits for Wall Street banks and hedge funds at Greece’s expense.
“Speculators are making billions every day betting on Greece’s default,’’ Prime Minister George Papandreou said this week in Washington. His government is pressing the United States to restrict such trading.
Greece favors banning “naked’’ credit default swaps on a country’s debt. In naked trades, buyers of the swaps don’t actually hold the underlying debt. Yet they can still profit or lose money.
Papandreou likened this practice to buying insurance on a neighbor’s house and then burning it down to collect. Without naming names, he said some US banks that were bailed out during the financial crisis are using naked swaps to make “a fortune out of Greece’s misfortune.’’
The Federal Reserve is investigating how Goldman Sachs and others are using derivatives. The Securities and Exchange Commission is examining the issue, too.