The backlash against the backlash against hedge funds and other traders of sovereign CDS has begun.
We quite liked this comment from Michael Hampden-Turner and his team:
As the proverb implies, we would do better to spend our time addressing the defects the mirror shows up than blaming the mirror. After all, banning mirrors does nothing at all to make the world a prettier place.
Analysts at BNP Paribas — known for being a trenchant bunch — joined the chorus on Wednesday (emphasis and links FT Alphaville’s):
Following harsh comments against sovereign CDSs made by French and British government officials, investors have started to fear the possibility of a regulatory backlash against shorting government bonds, whether through synthetic products or not. The FT reports that hedge funds such as Brevan Howard, Moore Capital and Paulson & Co. have all squared their positions on sovereigns, closing their shorts or reducing them to be net long or flat.
We think such concerns have grounds, given that regulators have already banned shorts on financial stocks in the recent past. The state of some countries’ public finances is certainly not speculators’ fault, but it is easier for politicians to put the blame on financial markets than on years of financial laxness – so we expect the backlash to continue.
However, while such remarks can effectively drive away speculators betting on a worsening of the crisis, investors who prefer (or need) to hedge their risk (such as certain banks and insurers), would be hurt by legal restrictions on sovereign CDS, and by the lack of players willing to provide them with insurance.
Besides, speculators’ impact of public finances is fairly limited in the short term. For instance, assuming that speculative protection buying added 100bp to Greece’s funding costs, that would translate into an additional cost on the country’s EUR50bn funding needs for 2010 of only EUR500mn – not a small number in absolute terms, but negligible compared to a stock of about EUR300bn of government debt.
Professor Craig Pirrong, also known as the Streetwise Professor, also weighed in against the criticism:
This is clearly shooting the messenger. As James Carville noted long ago, the bond market (and now, the CDS market), disciplines governments, and they don’t like it one bit.
Nobody likes market discipline, especially governments. But they’re the ones who usually need it the most. Hence we should resist cynical, self-interested calls to terminate CDS speculators, and instead pay more attention to the message they are sending about the unsustainability of fiscal policies in Europe, and around the world.