CDS not cause of Greek debt woe, US lawmakers told

* Credit default swaps did not cause Greek woes-experts

* CDS gave early warning on Greek debt, US lawmakers told

* Little sovereign debt protected by credit default swaps

By David Lawder

WASHINGTON, April 29 (BestGrowthStock) – Credit default swaps did
not cause or worsen Greece’s debt woes, but actually helped
markets realize the depth of its crisis, derivatives experts
told U.S. lawmakers on Thursday.

Greece’s debt problems, which have pushed it to request a
bailout from the International Monetary Fund and the European
Union, were of its own making, caused by Greece borrowing more
than it could repay, the academics and industry experts said in
testimony to the U.S. House of Representatives Financial
Services subcommittee on capital markets.

“Credit default swaps (CDS) are the current “villain du
jour” in the Greek debt fiasco,” said Anthony Sanders, a
finance professor at George Mason University in Fairfax,
Virginia. “The Greek crisis is the result of massive government
spending and debt issuance to fund the spending. In fact, CDSs
on Greek sovereign debt actually served a positive role: it
alerted everyone around the globe that Greece was in a credit
death spiral.”

Democratic lawmakers examined the issue as a way to further
their case for tougher U.S. regulation of the derivatives
markets and of credit ratings agencies. Some have criticized
so-called naked credit default swaps, in which no underlying
asset is hedged, for worsening the financial crisis by leading
to a build-up of risks.

Bad bets on CDS contracts by American International Group
Inc (AIG.N: ) prompted a taxpayer bailout of more than $180
billion for the insurer.

Bills passed by the U.S. House of Representatives and now
under debate on the Senate floor wold increase transparency for
derivatives by trading more standardized contracts through
exchanges and central clearing houses and requiring more
capital among those that do. One Senate proposal under debate
would call for banks to spin off their swaps trading desks if
they want to keep deposit insurance.

SMALL PROPORTION OF BONDS PROTECTED

But Thursday’s House hearing did not paint credit default
swaps as a culprit in the Greek woes, and experts said they
were not worsening problems for Portugal, Spain or California
for that matter. One reason is the relatively low proportion of
sovereign debt insured by CDS contracts.

Robert Pickel, executive vice chairman of the International
Swaps and Derivatives Association, the industry’s top trade
group, said credit protection had been purchased on only $2
trillion of the $36 trillion global government bond market.

And the net amount that could be paid out under these
contracts is much less — only $196 billion, or 0.5 percent of
government debt. The net amount payable on Greek bonds is $8.3
billion, or 1.9 percent of the country’s $426.8 billion in
debt, he said, while $7.7 billion, or 3.4 percent is payable on
Portugal’s $226.3 billion in debt.

Pickel said it was unlikely that CDS trading volumes could
have a significant impact on a country’s overall debt spreads,
and sovereign CDS also may moderate some downward pressure on
troubled countries. If sovereign CDS were banned, investors
would simply dump or short-sell a country’s bonds directly, he
said.

Darrell Duffie, finance professor at Stanford University’s
Graduate School of Business, said research he conducted with
Boston College professor Zhipeng Zhang found no statistical
correlation between amounts of credit default swaps on debt
issued by Greece and California and their borrowing costs.

What has caused Greek borrowing costs to rise is the
revelation of information that has decreased the probability
that investors will not be repaid, he said, adding, “It’s quite
hard to imagine how speculation by credit default swap
investors has caused Greece to borrow more than it can pay
back,” Duffie said.

U.S. Rep Paul Kanjorski, the Pennsylvania Democrat who
chairs the subcommittee, said the early warning signs on Greek
debt provided by CDS rates may mean more reforms are needed for
ratings agencies.

“After all, the cost for purchasing credit default swaps on
Greek debt has soared for many months, but Moody’s and Standard
and Poor’s have only downgraded the country’s bonds in recent
days,” he said.

Republicans used the hearing to urge caution in reforming
the market for derivatives.

“The events of 2008 demonstrate that there is a need for
legislation to address shortcomings in the regulation of
derivatives, but demonizing credit default swaps is not the
answer,” said Rep. Spencer Bachus of Alabama, the Financial
Service Committee’s top Republican. “Used responsibly,
derivatives are a critical tool for managing risks, including
the risk of sovereign debt.”

Investing Research

(Editing by Theodore d’Afflisio)

CDS not cause of Greek debt woe, US lawmakers told