It is not unusual to shoot the messenger who conveys bad news.
That is precisely what many European politicians have been busy doing after the fiscal crisis in Greece, a country with a public finance mess that makes the Indian budget look like a paragon of fiscal virtue. Traders in Greek credit default swaps (CDS) are being squarely blamed for creating panic about the solvency of the Greek government and worsening its financial misery.
However, the Greek tragedy does raise some important questions about the global market for CDS, a type of derivative that allows bond investors to buy protection against a probable default by a company or government that has issued the bonds. These derivatives play an important role in the global markets and often provide early warnings of impending problems; much before the credit rating agencies do so.
There is a growing chorus in support of reform rather than an outright ban on CDS trades. The key decision will be to move such derivative trades on to exchanges which have centralized clearing houses. Such a move will also go a long way in promoting financial stability—an issue that has leapt to centre stage in the past couple of years—to avoid what happened in the US in September 2008, when regulators realized too late in the day that AIG was a counterparty to most of the derivative bets by failed investment banks Lehman Brothers and Bear Stearns.
Given this, we welcome the news that financial regulators will have access to positions taken in over-the-counter derivative trades, thanks to a belated offer of cooperation by the DTCC Trade Information Warehouse, a clearing house for such trades. After this offer of transparency, regulators will have access to information after trades have been done, which is not as desirable as a total move to exchange-traded derivatives, in which case financial watchdogs can track information in real time and thus act sooner.
The financial crisis has led to an inevitable backlash against many practices of the financial industry and raised uncomfortable questions about the power of bankers.
What is needed is sensible debate on reform rather than a new and unwanted era of financial repression.
How should derivative trades be made more transparent? Tell us at email@example.com