Curbing Derivatives Might Hurt, Not Help, Greece

Derivatives have become a dirty word.

Treasury Secretary Timothy Geithner talks with Greek Prime Minister George Papandreou before their meeting, Tuesday, March 9, 2010, in Washington. (AP Photo/Haraz N. Ghanbari)

(AP)

The complex financial products helped blow up the U.S. housing market. They all but sank AIG. Now European officials want to crack down on a derivative called a credit default swap. It's an insurance-like product that they say has worsened Europe's debt crisis and could bankrupt Greece.

Hold on, many experts say: Credit default swaps — contracts that insure debt — have actually prevented Greece's debacle from worsening. Without them, they say, investors would be less willing to buy Greece's debt. It would likely need a bailout to run its government and service its huge debt. That could threaten Europe's economic rebound.

"If we get to a point where we've had enough with credit default swaps, then I think Greece will have serious problems," said Darrell Duffie, a finance professor at Stanford University.

Sellers of credit default swaps agree to pay the buyers if the debt goes bad. With swaps, investors who lend to countries by buying their bonds can reduce their risk. Without them, Duffie and others say, Greece's borrowing costs would escalate because lenders would demand higher premiums.

That's not how Greece sees it.

It argues that traders of the swaps who bet against Greece's debt are raising its borrowing costs, making default more likely. It claims trading of swaps — which is unregulated — is racking up big profits for Wall Street banks and hedge funds at Greece's expense.

"Speculators are making billions every day betting on Greece's default," Prime Minister George Papandreou said this week in Washington, where his government is pressing the U.S. to restrict such trading.

Greece favors banning "naked" credit default swaps on a country's debt. In naked trades, the buyers of the swaps don't actually hold the underlying debt. Yet they can still profit or lose money on the bet.

Papandreou likened this practice to buying insurance on a neighbor's house and then burning it down to collect. Without naming names, he said some U.S. banks that were bailed out during the financial crisis are using naked swaps to make "a fortune out of Greece's misfortune."