The Witch Hunt Continues and Fidel Castro liked it...

Dear readers,

From both sides of the Atlantic more worrisome signals were sent out to the market that the populism, which struck the market after the Lehman fallout, is continuing.

The turmoil around Greece and its public finances have brought hedge funds and rogue traders back into the spotlight. They are blamed to have caused the crisis and creating unnecessary unrest both on the markets but also in the streets of Athens.

Politicians are jumping on the same bandwagon that was put in motion late 2008 when bank stocks came under fire as the hedge fund industry questioned the healthiness of the entire financial industry. Back then government officials tried to mule the crisis by putting a ban on “short-selling” of financials in the stock market.

A similar reflex is in the making right now as the PIIGS, and Greece more in particular, are under attack from market players in the Credit Default Swap (CDS) market. Market participants simply view the health of the public finances as problematic as that of the banking industry back in 2008, and respond to the situation via buying protection on sovereign names

However our “world leaders” find this as unacceptable as a woman being a priest in the Vatican.

A first response came from the US where the US government ordered the hedge fund community to keep track of every trading record on EUR positions either in the currency market or in the CDS market as it will be subject of an investigation to see whether there was a “speculative” attack on the said sovereigns or on the currency.
Of course Germany and France couldn’t stay behind and are pushing for hard line measures against these so-called sinners / speculators. Angela Merkel and Nicolas Sarkozy have urged the Chairman of the EU-Commission José Manuel Barroso to take an initiative.
One of the suggestions is to ban trading in CDS’s, at least on sovereigns. A similar idea was already launched by the Minister of Finance in Belgium, Didier Reynders, who has a surprisingly high reputation among the G-20 Ministers of Finance (as per FT ranking published late last year).
In the meantime Greek Prime Minister George Papandreou is even going on a mission to convince President Obama to help Europe against these “unprincipled speculators” .To further quote the Prime Minister: “Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system.” It even gets better when Mr. Papandreou is arguing further that due to driving up the CDS spread Greece now has to borrow at rates almost twice as high as any other EU country. He continuous by saying: “So when we borrow 5 billion euros ($6.8 billion) for five years, we must pay about 725 million Eur more in interest than Germany does.”
An obscene idea is crystallizing among governments around the world that hedge funds and the use of CDS’s are to blame for the public finances and banning them would solve the problems. A better sophism couldn’t be created.
Apart from the core of the discussion where we will come to in a moment, data provided by the U.S. Depository Trust & Clearing Corporation downplay the allegations towards hedge funds. According to its findings there is no sign of new open positions being build up and neither is there an indication of “massive speculative action,” this according to a BaFin official statement on Bloomberg.

However, the core of the matter is that politicians do not have the courage and ambition to push through structural reforms that are urgently necessary to cope with the imbalances that are still in place and which triggered the Great Credit Crisis 2007-2009 initially. We already indicated that in our previous column on the ageing of society.

The public finances are in such an impaired state that investors, who properly do their home work, can only come to one conclusion that the current risk premiums that certain sovereigns are offering for their bonds are simply too low.

Therefore hedge funds and other global macro investors are making the market more efficient by pointing at the problem and taking on positions against these anomalies. In stead of blindly focussing on the astronomic profits they sometimes make, one should look at the initial goal they are focussing on, that is getting rid of inefficiencies which otherwise would keep on existing for an extended period of time.

At this moment especially, global macro players, who continuously screen macro-economic inefficiencies, are at play against sovereign entities, but they are doing exactly the same as the likes of private equity players or other hedge funds that have an active investment strategy in the corporate industry.

Of course some melancholic socialists will consider these hedge funds as the antichrist brought to earth by crony capitalism. But bear in mind that long before hedge funds existed, our economies were featured by (government owned) monopolies and cartels which could hide their inefficiencies and overcharge the consumer for this.

Not only state companies are being put under pressure by these financial wizards, also privately owned companies do not escape from it, but then unions heavily protest against these devil incarnators. If we look at Germany for example, their corporate industry was chased up by private equity investors to make them more efficient, and modernized its entire industry over the last two decades.

Indirectly they put pressure on the German government to become more flexible, more productive and a competitive player in the globalized world. In the meantime the contrast becomes only more painfully noticeable with countries such as Italy, Spain, Portugal and Greece to name a few, that did not find it necessary to respond to the needs that globalization brought with it.

The same is taking place at this very moment in the sovereign bond market. Market players, as we refuse to call them speculators who only flip a coin and see what the outcome is, are poking the finger in a tedious wound. They have done their homework thoroughly before they decided to put their capital at work against the likes of Greece and potentially other countries.

In this way they are forcing the local governments to start finally doing something against the state of the public finances. Obviously politicians do not like this, as they have to take extremely painful measures they have postponed for too many years. Therefore it is easier for them to shoot the messenger.
To the extent it would be possible to ban CDS trading, it would have devastating effects to the global economy. To use an analogy, despite the daily number of accidents nobody has ever raised the idea of banning cars. Instead governments continuously work on traffic rules and regulation on how to make cars and driving safer. This is how derivatives should be approached as well.
If not we run the risk of turning the back the clock 15-20 years which will come at the expense of liquidity. This would also mean we would step back into the dark ages where inefficient government interventions are ruling our world again, where entrepreneurial initiatives are considered to be “not done”. It is certainly a society where Fidel Castro would prosper, but those who have not been there we invite to emigrate (temporarily) and compare the difference in living standards.