New Greek drama resurrects a very old and muddled myth

PUBLISHED : Thursday, 20 May, 2010, 12:00am
UPDATED : Thursday, 20 May, 2010, 12:00am

By first buying the CDS [credit default swap] and then trying to affect market sentiment by going short on the underlying bond, investors can make large profits

Jean-Claude Trichet

president European Central Bank

He makes it sound so easy. You just buy insurance on the price of the bond and immediately afterwards you short the bond. The bond's price then drops and you collect on the insurance. Whoopeee! Anyone can be rich.

Let me point out that after doing his stint at the Ecole Nationale de Maladministration (Enamal), an institution whose graduates have done more to impoverish the French taxpayer than any conceivable collection of Greek bonds could ever do, Trichet embarked directly on a lifetime career as a bureaucrat and has never seen fit to dirty his hands with a real job in finance.

I doubt that he has ever bought a bond for his own account in his life, leave alone shorted one.

Here is a little truth that needs repeating until one day it manages to get through the earplugs generally worn at the European Central Bank to avoid acquaintance with the real world - vultures do not feed on live meat.

You cannot blame the speculator for the negligence of central banks and finance ministries.

All the speculator does is take advantage of the weaknesses that such institutions themselves create in their currencies and securities. He does not cause financial excesses. His activities on the market rather serve to reveal them before they become disasters.

In the case of the Greek bonds to which Trichet was indirectly referring in the excerpt above, it was fiscal negligence and deceit on the part of the Greek government that caused investors to lose confidence in Greek sovereign bonds.

But if these investors were wrong about these bonds, then shorting them would have created large losses, not large profits. When you short a financial instrument you impose an obligation on yourself to buy it back at a later date. In the famous words of the American 19th-century speculator, Daniel Drew:

Him what sells what isn't his'n

Must buy it back or go to prison

If these Greek bonds were sound, then shorting them would not have sent their price down, or only very little, while buying them back later would send the price way up.

It is a very dangerous business to short financial instruments that are fundamentally sound. It doesn't matter if you add a credit default swap to the mix. It's still dangerous. Only small speculators do it. It is why they are small speculators.

But Greek Prime Minister George Papandreou, for one, is doing his very best to pretend it ain't so. We quoted him the other day as saying: 'This is where I think, yes, the financial sector, I hear the words fraud and lack of transparency, so yes, yes, there is great responsibility here' [Greece considers suing US banks, May 17].

I have heard the words fraud and lack of transparency too, Mr Papandreou. When I heard them they were invariably used of the Greek government and yet you have the gall, Sir, to pretend that it has nothing to do with you and that this 'great responsibility' of which you speak is someone else's.

No wonder Greece's finances are in a mess.

I shall confess my own interests here. A portion of my own investment portfolio is denominated in euro instruments and I have, of course, been a little unhappy to see the euro so weak recently.

But I speak only of a degree of unhappiness. Far worse, a cause for dismay, is to see Greek bond prices recover as rapidly as they have done since the ECB approved supporting profligate member governments with support packages of hundreds of billions of euro.

It's bad enough to see European politicians walk away from messes they have themselves created, as Papandreou is obviously trying to do. But things are much worse when the ECB then turns coward and takes the easy way out, too.

If this is the way of the future for Europe then here is a forecast that cannot fail - the euro is doomed.

There is one thing very peculiar. Some people say you must push down property prices so they can afford to buy. You can see that the largest number of people rush to make a purchase when the market is on the rise. But when the price drops, no one is buying

Chief Executive

Donald Tsang Yam-kuen

On Metro radio, May 17

Donald, in case you didn't know it, this town you're living in, it's called Hong Kong and people here don't usually make a practice of losing money by buying in on falling markets. You can try it yourself, of course, go ahead. But ahhh ... do please remember, this town, it's called Hong Kong.