Greece Downgraded. EU Looks to Ban Sovereign Credit Default Swap Speculation

Greece has been downgraded by Moody's:

Moody's slashed Greece's credit rating by three notches on Monday due to an increased default risk, raising the specter that the distressed euro zone sovereign may have to restructure its debt, perhaps before 2013.

The move increased pressure on euro zone leaders to ease repayment terms on bailout loans to Athens, just as Germany and its allies seem to have turned their backs on more radical steps to help it reduce its debt through bond purchases or buy-backs.

Moody's Investors Service downgraded Greek debt to B1 from Ba1 -- lower than Egypt -- and said it may cut further, drawing an indignant protest from the Greek Finance Ministry.

This downgrade caused Greece's Credit Default Swaps to hit a record high:

  • Five-Year CDS On Greece Hit 1035BPs Intraday, Above Record Close of 1032BPs
  • Cost Of One-Year CDS On Greece Rises 6.1% - Markit
  • $476 Mln New CDS Traded On Greece In Week Ended Feb. 25 - DTCC

The cost to insure EUR10 million of Greek bonds for five years spiked 5.3%, or $52,000 a year,

Meanwhile the EU just did something completely practical, they just voted to ban CDS speculation:

The European Parliament voted Monday to stop investors from buying insurance for government debt if they don't own the underlying bond, as it seeks to fight financial speculation.

The Parliament's Monetary and Economic Affairs Committee endorsed changes to the proposals from the European Commission, the European Union's executive, on so-called credit default swaps, which have been blamed for pushing up borrowing costs for financially distressed countries like Greece.

Investors can buy credit default swaps for sovereign bonds in order to insure against the default of a country.

However, at the moment investors can also buy a CDS for a bond they don't own, basically betting that the cost for insurance will go up and they will make a profit.

The proposal now has to go to EU governments, which are divided over the Parliament's ban.

The Alternative Investment Management Association, which represents hedge funds around the world, opposed the Parliament's ban, saying there was no proof that uncovered credit default swaps have any effect on bond prices or push up borrowing costs.

Let's hope the CDS speculation ban passes. It is absurd to allow anyone to bet on a CDS. This creates systemic risk and contagion. It's like knowing some arsonist is going to set a block of houses on fire, yet allowing a person who knows the arsonist's penchant to play with matches to buy insurance on those very houses, right before the match is struck. That CDS buyer is simply placing gambling bets the houses will burn to the ground. He doesn't own 'em, or even live on the block. How ridiculous is that?

Right now Portugal is getting hit on high CDS pricing for it's seen as the next domino to fall in the European sovereign debt crisis.

Yields on Portugal's 10-year bonds hit a euro-era high of 7.5% Monday as bond markets predicted that Portugal will follow Ireland and Greece and become the next euro-zone country to ask for financial support.

Let's hope the EU Parliament isn't beaten back by the hedge fund lobbyists.

Angry Bear wrote up an analysis of credit ratings versus real financial health and explains how justified Greece's rage at Moody's is right now.

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