Thursday, February 25, 2010

Financial equivalent of a four-alarm fire

Bets by some of the same banks that helped Greece shroud its mounting debts may actually now be pushing the nation closer to the brink of financial ruin. 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.

These contracts, known as credit-default swaps, effectively let banks and hedge funds wager on the financial equivalent of a four-alarm fire: a default by a company or, in the case of Greece, an entire country. If Greece reneges on its debts, traders who own these swaps stand to profit.

“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.

And reform is dead in the US Senate; a repeal of the laws allowing banks to use their own capital for investment banking will not pass. What will it take for reform to pass? The US economy almost fell off the edge. Greece is teetering, and if it falls the repercussions in Europe will be awful.

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