Echoing the kind of trades that nearly toppled the American International Group, the increasingly popular insurance against the risk of a Greek default is making it harder for Athens to raise the money it needs to pay its bills, according to traders and money managers.
Contracts known as credit-default swaps, effectively let banks and hedge funds wager on the financial equivalent of a four-alarm fire, such as a default by a company or, in the case of Greece, an entire country. So, if Greece reneges on its debts, traders who own these swaps will profit big-time.
"It's like buying fire insurance on your neighbor's house -- you create an incentive to burn down the house," said Philip Gisdakis, head of credit strategy at UniCredit in Munich.
As Greece's financial condition has worsened, undermining the euro, the role of Goldman Sachs and other major banks in masking the true extent of the country's problems has drawn criticism from European leaders. But even before that issue became apparent, a little-known company backed by Goldman, JP Morgan Chase and about a dozen other banks had created an index that enabled market players to bet on whether Greece and other European nations would go bust. That company, the Markit Group of London, introduced the iTraxx SovX Western Europe index, which is entirely based on such swaps, and let traders gamble on Greece shortly before the crisis. Such derivatives have assumed an outsized role in Europe's debt crisis, as traders focus on the daily gyrations of countries struggling to avoid the bankruptcy into which they are being cleverly forced (for the sake of the immense profits to be made in the attendant gambling casino that has been set up for precisely this purpose).
What has been set up here, for betting purposes, is a vicious circle. As profit-seeking banks and others rush into these swaps, the cost of insuring Greece's debt rises accordingly. Then alarmed by that bearish signal, bond investors shun Greek bonds, making it harder for the country to borrow. That, in turn, adds to the anxiety -- and the whole cycle starts over again.
While some European leaders have blamed financial speculators in general for worsening the crisis, the French finance minister, Christine Lagarde, last week singled out credit-default swaps. Ms. Lagarde said a few players dominated this arena, which she said needed tighter regulation.