The last bailout plan for Greece, voted yesterday, was announced as being successful. 

It does only one thing : help the politicians (this is an electoral year for many countries) buy some time before Greece defaults entirely, keep the technocrat “European” project going for a while, and prevent (for the time being) other countries from exiting the Euro zone.

But the real danger with a Greek default is the activation of the credit default swaps, or CDSs (Credit default swap), which are essentially insurance bets against debt default by a country.

The credit default swap market is estimated at 32 trillion dollars. Only five banks are exposed to 95% of that market : JP Morgan Chase, Citigroup, Bank of America, HSBC and Goldman Sachs.

The credit derivative market is not regulated, so there is no obligation for the CDS sellers to actually back up those bets with real money.

The majority of those CDSs were issued by American banks that won’t be able to pay for those “bets”.

The danger is worse because the leverage on those “bets”, some say 40 to one, is enough, with just Greece defaulting, to cause major havoc and bring down the inter-connected global financial system.

Greece’s CDSs Are a Real Financial Time Bomb

The International Swaps and Derivatives Association (ISDA), the organization in charge of regulating the credit derivatives market, has qualified the Greek default as “voluntary”, thus making sure MF Global would explode. MF Global had gone all the way with these CDSs and had expected to cash in on those bets when Greece announced a default on 50% of its debt… but the ISDA decided otherwise.

This magic trick by the ISDA seems to show that the issuers of those CDSs, the large American banks, are in no position to pay for that insurance.

The ISDA is controlled in majority by the great international banks, which can certainly explain why the Greek default has been qualified as “voluntary” up to this day.

Things might get more complicated for the financial institutions if the upcoming April elections in Greece bring to power a political party intent on defaulting entirely, because those CDSs will become due…what will the ISDA do then ?

We should know this coming March, if the actual government goes for a total default following the social unrest generated by the austerity measures, or in April after the elections.

Greece is a relatively small country in regards to global economy, but the leverage in the financial sector is such that its bankruptcy could have systemic consequences.

There is no solution for the situation in Greece. You cannot cure a sick man by giving him enormous doses of morphine (debt), while asking him to go on a radical diet (austerity measures).

Greece is stuck between the obligation to repay a colossal debt and the impossibility to repay it. There can be no growth with such radical austerity measures, because there is no money left to pay the debt.

Greece will certainly default, but no one can anticipate the size of the chain-reaction financial catastrophy that will be brought about by the CDSs : Bank failures ? Nationalizations ? New bailout plans (more debt, more money printing) ? Most certainly.

The only solution for Greece is to follow Argentina’s example of a few years back by defaulting on its debt, but with the consequences I’ve just explained in regards to the credit derivatives market’s explosion.

Reproduction, in whole or in part, is authorized as long as it includes all the text hyperlinks and a link back to the original source.

The information contained in this article is for information purposes only and does not constitute investment advice or a recommendation to buy or sell.