An interesting programme on BBC Radio 4 the other evening gave me, for the first time, an insight into Negative Credit Default Swaps (NCDS). Like me you may not of heard of them, but they are essentially bets taken out on a Credit Default Swap (CDS) - which is an insurance policy to protect someone if someone (or country) defaults on a debt. Confused? I'm not surprised. These things are not really discussed amongst the sort of people I mix with - perhaps they should be!
An on-line journal Investapedia (see http://www.investopedia.com/articles/optioninvestor/08/cds.asp#axzz1RGDdr8Yc) gives some insight into CDSs, a financial market estimated to be worth $45 Trillion (yes, Trillion!). On top of this market sits a further casino of betting called NCDSs.
What this article does not say, however, but the BBC programme did, is that CDSs and NCDSs are one of the major causes of the financial crisis that we are in, and in particular for countries like Greece and Ireland, since those who hold NCDSs have been lobbying hard to force a default on Greece's debt by insisting on severe measures against them and lobbying Governments to up the interest changed on the debts that Greece owes, or on future loans they may wish to take out. Why is this?
NDFSs are held by major global financial institutions who have a vested interest in Greece defaulting on its debts as this would then result in those who hold the debt claiming from those who sold them CDSs. Those who have placed bets on CDSs having to be paid out (NCDSs) gain substantially as their "number will have come up" in the international financial lottery game.
So (you still with me?), if a country like Greece defaults on its debts, those who hold CDFs loose money. On the other hand those who hold NCDSs will win. If Greece doesn't default, those who own CFSs win (because they get the insurance premiums, but don't have to pay out on the policy). But if Greece doesn't default those who own NCDSs loose!
So, who owns the debts, the CDSs and NCDSs? Surprise, surprise - they are all owned by different part (and sometime the same parts) of the international financial system. So, who wins if Greece defaults? Part of financial system. And who wins if Greece doesn't default (because of austerity measures in other countries to under-right the losses to those who own CDSs)? Parts of the financial system!
Who losses if Greece defaults? The Greek people - as their economy nose-dives even further into recession. And who looses if Greece doesn't default (because of the severe austerity measures demanded by the financial system to get loans)? Well, the Greek people (and ordinary people across Europe and elsewhere) of course - silly me!
So its all a little less confusing now - isn't it?
Postscript: I hope that my understanding of this complex area of international finance is correct - if it isn't, I am sure someone somewhere may provide the necessary illumination!
Read more: http://www.investopedia.com/articles/optioninvestor/08/cds.asp#ixzz1RGFCTZoc