CDS: Just Another Evanescent Bubble?

More on the Greek debt crisis from Naked Capitalism: German Paper Says AIG May Have Sold CDS on Greece. That German paper would be the excellent business-sheet Handelsblatt, and the full translation of the article into English which that blog’s proprietor requests in her post follows after the jump. http://www.nakedcapitalism.com/2010/02/ ... l#comments

UPDATE: Correction! Looking at that original German piece, it clearly comes originally from the Frankfurter Allgemeine Zeitung or FAZ – often called Germany’s own New York Times. I have noticed before how the two papers clearly have an arrangement allowing Handelsblatt to reprint certain FAZ material. Credit where it is due . . . http://m.faz.net/Rub645F7F43865344D198A ... ontent.xml

The fever-curve of the Greek debt crisis
By Markus Frühauf
20 February 2010

Trade in the risk of Greek insolvency in the past five months has enabled fantastic earnings. That is made clear by the price-development for credit-default insurance on that financially-weak Euroland. On 16 October 2009 a Credit Default Swap (CDS), which investors use to insure themselves against insolvency from Athens, still cost 123 basis points (1.23 percentage points). This meant a yearly premium of 12,300 euros in order to insure a claim on 1 million euros. On 4 February the insured had to pay 42,820 euros for that, a fee three times as high. Greece’s risk-premium – in market jargon the CDS spread – is the fever-curve of the debt crisis.

For the growth in the expense of the insurance against non-payment reflects the reduced creditworthiness of the country. Speculation in the CDS market began after 4 October 2009, as the Greek Socialists celebrated their election victory. Two weeks later the newly-elected government informed its Euro-partners that the deficit for 2009 was going to lie at 12.7 percent of economic performance (GDP).

Timidly, but steadily
That was a shock, since the previous conservative government had prognosticated precisely half of that. The new estimate for the budget deficit called onto the stage the first hedge funds, reports a London CDS-dealer working for a large American bank. In view of Greece’s previous history of cheating its way into the monetary union with false budget statistics, at that point a wager on Greece having payment problems was promising. This bet in the meantime has become obvious.

The rise of the Greek risk-premium at first still continued timidly, but steadily. It could be that that hedge funds had been the first to recognize Athens’ exhausted budget situation but had bet in the CDS market on a fall in the value of Greek debt with little commitment of capital. But the new Greek government’s commitment to transparency unleashed this speculation. The further rises in the CDS spread were accompanied by fundamental factors as well. On 8 December 2009 the Fitch rating agency downgraded Greece’s credit-rating from “A-â€