Thursday, 11 March 2010

CDS fail

People don't understand CDS. I guess that fact should be obvious - it's a relatively complex tool used by financiers to make money, sometimes in situations where others are losing out. Like short-selling, it appears to have given politicians in Europe something (anything!) to rail against and as with the short-selling ban it is unclear what the evidence there is to support the vituperative attacks. (Indeed, as time as gone by there appears to be less and less evidence that short-sellers were to blame for problems with banks.)

Here is a brief explanation of what was going on with Greece: it seems as though hedge funds sold CDS to banks to protect the banks against a possible default by Greece. More here and here and a lengthy and wide-ranging one here. The CDS became more desirable - and the price rose - as Greece found an enormous black hole in its finances, a media and political storm became whipped up, and some banks panicked. None of this stopped Greece eventually selling its bonds (to those evil foreign investors that it relies on), but neither did it stop European politicians capitalising on all this froth to try to ban an element of finance capitalism they seemed not to understand.

It is an interesting question to ask whether it matters if policy has to come from evidence. Many people seem to believe that politicians should act just because a group in society is angry, often at wide variance to the facts. This is a form of populism, and it has a long history. Unfortunately most of this long history is of making people, particularly those in identifiable minorities, sad, poorer and/or dead.

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