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The Index Villains

Written by Paul Amery

  
March 04, 2010 10:33 PM (CET)

Who knew creating indices was a shortcut to international super-villainy?

Markit’s amiable index head Stephan Flagel and head of credit indices Tobias Sproehnle must have been surprised to find themselves painted as Blofeld-type characters in a letter sent last week by U.S. representative Carolyn Maloney to Barney Frank, chairman of the House Financial Services committee.

“News has surfaced that investment banks based in the United States have funded firms that created the financial indexes and other information needed to trade against the possibility of a sovereign default overseas,” Maloney wrote.

“News has surfaced”, “funded firms”, “information needed to trade against” – clearly, those index providers are involved in a clandestine plot of some kind. Markit has a glass-fronted office on London’s Thames that would be convenient for a river chase, something Maloney forgot to mention…and wasn’t that a white Persian cat I saw during my last visit?

But perhaps I shouldn’t joke. According to MarketWatch, the US justice department has requested that three hedge funds preserve documents related to their trading in the euro. Meanwhile, French economy minister Christine Lagarde is on record as saying that trading in sovereign credit derivatives should be “rigorously regulated, limited or banned.” And Jean-Claude Juncker, head of the Eurogroup of finance ministers, even said this week in an interview with German newspaper Handelsblatt that “we have the torture equipment in the cellar, and we will show [the speculators] if needed.”  That’s “Wir haben die Folterwerkzeuge im Keller” for you, Stephan and Tobias.

What’s causing the outrage? The existence of sovereign CDS “accelerates the requirement for a response to deal with local country deficits and structural eurozone imbalances,” according to Andrew Clavell in a blog where he comprehensively debunks the criticisms of these instruments. CDS markets are simply telling politicians something they don’t want to hear regarding their deficit spending.

But, judging by the panicked attempts by regulators to ban short selling of financial stocks (and, in many cases, all stocks) in 2008 – just as company shares were pointing out the insolvency of large parts of the banking system – there must be a good chance that some kind of serious attempt will be made to clamp down on sovereign CDS trading.

And, equally, given that the ban on financial stock short selling didn’t work (most of the bank share price declines in 2008 came after the bans were introduced, not before), there must be an even better chance that the politicians who interfere will blow up their own government bond markets as a result. Why? Because CDS are used primarily as a hedging instrument and if you remove the hedging instrument you remove some of the demand for the bonds that governments are under such pressure to sell this year.

It’s shaping up to be an interesting second half of 2010.

 

 




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