Aren't the markets being beastly to the Greeks?


Read any of the commentary in the left of centre (or "economically illiterate" as I prefer to call them) papers and you'll see the anguished cries, the calls to the barricades, about how those nasty markets are forcing the Greeks into penury, making them stop borrowing money. If only we could stop the speculators then everything would be wondrous and kittens would again be cute.

Those sufficiently literate to recognise the difference between a CDO and a CDS go on to point out that those speculators, by being able to bet on a falling price for Greek Government debt, make that fall more likely (or even engineer it) and thus they are the vampire squid sucking the blood from a veritable social paradise, where pensions and benefits are paid for on the never never. So, goes the reasoning, if we ban people from buying a CDS then the problem goes away, Greek yields fall and the problem goes away.

Well, yes, but, you see, that isn't what is actually happening:

In English, what this means is that the spread on Greek bonds is substantially larger than the spread on Greece CDS. As a result, you can theoretically lock in a risk-free profit by buying Greek bonds and at the same time buying credit protection on them: the cost of the protection is lower than the yield on the bonds, and the rest of your coupon payments is pure profit.

This also means that you can’t blame the CDS market for sending Greek bond spreads gapping outwards — if anything, the opposite is the case, and Greek bond spreads are probably responsible for upward pressure on Greek CDS spreads. Once again, if you own Greek debt, the CDS market is your friend: you’re better off buying protection on that debt than you are simply selling your bonds outright.

As Felix Salmon points out, the speculation here in the CDS market is *reducing* the interest rate the Greek Govt must pay. For the speculation is that current yields are too high, thus people are buying the bonds in order to enter into this profitable trade and part and parcel of that profitable trade is that they buy a CDS at the same time.

An amusement, don't you think? People desiring to ban the very thing which is preventing matters from getting even worse?