Bring on the Creditors! Let the games begin!

The FT reported last night that Dubai World executives are in London this week presenting their proposals for the Dubai World restructurings to the various creditors of Dubai World. This is the opening move what is likely to be the final act in the Dubai World saga. Nothing has been communicated to the public but the possible structures of the restructuring have been fed to the press and commented on in this blog and others. They are generally that the terms of the proposal may include some or all of the following: extensions of term, haircuts, government guarantees, securities swaps. It is also likely that there will be choices between degree of those things such as those who accept longer terms have greater return of principal and perhaps a government guarantee. I have no idea or special insight into what will be proposed or what will transpire but I want to point out a few things that might be helpful as the drama unfolds.

For all their outward unity Dubai and Abu Dhabi have very different objectives in resolving the crisis.
It’s like the roles of the chicken and the pig in making your breakfast of bacon and eggs. The chicken is involved, the pig is committed. For Abu Dhabi this is an exercise in reputation management, for Dubai it is life and death. In the event of a a litigious liquidation of Dubai World Abu Dhabi will be deeply embarrassed. Dubai would be destroyed by that outcome, even if the parent company were saved but there was a messy unwind of one of the subsidiaries that threw into question the security of creditors in Dubai. This is because this would likely shut the capital markets to Dubai and its infrastructure based development would grind to a halt.

All Creditors are not created equal.
The creditors will have varying degrees of power relative to the degree to which they have recourse to assets held outside the UAE. This is because they can litigate in those jurisdictions and achieve a greater recovery. I think it was a good step for the Dubai to establish the DIFC Tribunal for claims against Dubai World but it is untried and it is probably still likely to confer a, let’s call it “home field advantage” in litigation with creditors. Dubai’s power with the creditors varies to the degree that the creditor is interested in maintaining a relationship with Dubai or perceives that strong arming Dubai will damage its relationship with Abu Dhabi. The bank lenders at the holding company level probably have the most to gain in international litigation but the most to lose in terms of damage to their relationships if they do that. The hedge funds who have bought Nakheel sukuks don’t care about their relationship with Dubai but have recourse only to non-existent Arabian/Persian Gulf islands and therefore, in my opinion, are screwed.

More people can buy the bonds than can take possession of the collateral.
This is an issue that I have not really seen raised as yet but I think that in the event of a liquidation of any of the real estate subsidiaries a disconnection between the ability of someone to lend money against an asset they cannot possess may have a sever effect on real estate throughout the region. This is an important but subtle point that may best be addressed through an example. There are no restrictions on who can own the Nakheel Sukuks. Anyone can buy them, indeed a great many of them are held by western hedge funds at this stage of the game. The land which secures them however can only be legally owned by GCC nationals. This means that the supply of capital to finance real estate is vastly greater than the supply of capital which can actually take possession of that real estate in event of default. This may mean that the debt is overpriced relative to the assets that secure it. In the event that Nakheel is liquidated the prices that result at auction to GCC nationals will probably be vastly less than if they were held in an open auction at which anyone could purchase them. This has the potential to illustrate to other international creditors the disconnect between owning debt and having recourse to the securing asset. This may choke off international finance to local real estate projects and further depress prices.

It is overwhelmingly likely some, perhaps a great many, of the creditors will refuse the terms on offer and seek to litigate.
This is just my opinion but I think that the facts are generally the following: things at Nakheel are far worse than most of the creditors understand. What seems clear is that whatever Dubai offers most of the creditors are going to have to take very substantial losses. I think the Dubai Inc. marketing machine and the generally opaque nature of its financial disclosure has created an unrealistic sense among creditors as to how likely they are to be repaid. Add to this the fact that Dubai has significantly damaged its credibility over the past few months. The creditors may be tempted to believe that Dubai Inc. is just leading with an aggressive bid to establish a strong negotiating position. This may lead them to call what they consider to be Dubai’s bluff. The only way for the cards of either side to be shown is in a liquidation and that is where I think we are going at least in the case of Nakheel.

Trying to get a few more seconds out of my 15 minutes of fame.

So after an illustrious career in finance I have finally made the FT. So if you didn't already know who I was, now you do. I agreed to let the FT use my real name in an article about middle eastern blogs.

Naturally the day they publish this what do I have up? A joke article about the recent assassination in Dubai. So to give you a sense of what this blog is all about I'm going to publish a list of some of the more popular articles.

There is one on the logic behind the Arabtec Merger.

One of the DIFC, the the Damas Heist and the DFSA.

I also wrote one about expat schadenfreude.

And a post which comes as close as I have to explaining why I am doing this.


Enjoy, and feel free to comment or email me at ken@wallstwtf.com

Thank you friend readers for your unseen but everfelt presence.

The next time the Israelis decide that someone has to get got they need to send someone with real tradecraft, like Zohan.

I didn’t really want to write on this subject but people have been emailing me the craziest conspiracy theories about this. The best one so far was that Sheikh Al Thani of Qatar secretly flew to Dubai to present an offer from the Israelis to pay off Dubai Worlds debts in return for silence on the assassination. Why the Israelis would go through Qatar rather than the US for something like that I don’t know. As embarrassing as this is it’s not exactly a secret that this sort of thing happens but usually the hush money is vastly cheaper than a Dubai World bailout. Sorry Nakheel bondholders, no Zohan rescue for you.

I know this is a politically tense thing, if you’re an Emirati you’re probably really mad. If you’re an Israeli you probably wonder why everyone is so mad. If you’re a poor schlep with a western passport who spends a lot of time in visa lines in the Arab world, get ready to spend a lot more time in them. Personally I don’t really have a dog in this fight. Both the guy who died and the guys who killed him knew the game and that it has only one rule: win or die.

The thing that I don’t understand is why the hit was so sloppy, aren’t these the best guys in the world? It was a neat trick using an electromagnet to close the latch on the guy’s room from the outside. Well done there and they surely used a big enough team to surveil him and then finally get him though they were probably counting having to overcome more security than they did in the end. As for the rest of it however, I’m no expert but I’ve read enough Ian Flemming and Alan Furst to know a few things. So for anyone else planning an assassination here are my tips.

Number one, if you are going to use fake documents to enter a country surreptitiously it is probably NOT A GOOD IDEA TO FAKE THE PASSPORTS OF DUAL NATIONALS WHO LIVE IN YOUR COUNTRY. While this might make it easier for you to make really good copies of the passport it kind of leaves your fingerprints all over the place.

Also, if you are going to do your hit in a major tourist destination with scores or hundreds of hotels like Dubai DO NOT STAY IN EMIRATES TOWERS WHERE YOU WILL BE UNDER CONSTANT SURVEILANCE, TAPES OF WHICH CAN THEN BE PUT ONTO YOUTUBE. There are any number of no-tell motels all over Dubai or better yet stay in the Embassy Suites in Sharjah. The place barely has electricity and running water, they sure as hell don’t have security cameras watching your every move. The getaway car might get stuck in traffic but you can be sure of not showing up on TV.

Most importantly, FAMILIARIZE YOURSELF WITH THE COUNTERINTELLIGENCE CAPABILITES OF THE NATION WHERE YOU ARE DOING THE HIT. Something tells me that the guys over at Mossad are scratching their heads wondering how in the name of God the Dubai police are all over this thing. I mean even if they got the killers on tape going into and out of the room where they did the killing how did they match them up with the people who checked into all the hotels and went through customs? Granted the disguises were pretty weak but there are literally a huge number of people who check into and out of these hotels from all nationalities every day. How did they do it? And so quickly.

I think I know. Someone once told me that Dubai had implemented a system that the police in Monaco use to track people moving around the city. As every cellphone activated itself in Dubai a computer began tracking and triangulating it and then recording its location as it moved around Dubai as well as recording at the very least who it called, who called it and perhaps even what was said. All this data was then stored in memory and run through pattern recognition software. There were always stories about the Dubai police having an uncanny knowledge of peoples whereabouts or arriving at the home of person who committed a hit and run before they did. I heard that this system was used to keep the Indian labourers from organizing a union. Things like that, but I never believed it. It looks like maybe I was wrong. It looks like perhaps Dubai does have such a thing and the agents were using cell phones which the Dubai authorities were able to triangulate to the room of the victim then go through the database and see who else was in proximity to them. Clever.

Of course there is another reason why the Israeli tradecraft might have been so shoddy: they want you to know.

Darn it, every time we order Chinese I get the same fortune "You will own more Dubai assets."

Generally if you are a blogger the prediction business is a bad business. This is because it is pretty easy to look up your old predictions and find out whether they worked out or not. In an earlier incarnation of this blog I recommended two trades. One was a sale of SPY strangles which manifestly did not work out. The other was trading a reverse collar on gold which has worked out quite well. In my last post I tried to predict the prices of all assets in dollar bloc countries based on an attempt to read the mind of the Chairman of the Federal Reserve. I know it’s a bad business but in this case I can’t resist.

So what have we found out about the Dubai World saga in recent days? Interestingly Arabtec and Aabar have extended the due diligence period. This is a little disturbing but more interestingly Arabtec, now that it is almost going to be owned by Abu Dhabi has stopped work on a Nakheel project because Nakheel has not been paying it. Do you think Arabtec would have stopped this work if Abu Dhabi were not involved? I think not. So what does it say about Abu Dhabi support for Dubai World if one of its own future contractors has stopped work on Nakheel for lack of payment? Nothing good.

There are also the recent reports out from Moodys and the IMF about the exposure of the Emirati banking system to Dubai World. It turns out that the exposures of ADCB and Emirates NBD to Dubai are quite substantial. Emirati banks are owed something on the order of $15 billion by Dubai World entities and billions more by other government related entities. The IMF suspects that massive amounts of capital will have to be raised by the Emirati banks in the event that there is a partial recovery to the creditors of Dubai World, especially if it is on the order of $0.60 on the dollar.

And what of that report that the $0.60 on the dollar figure was something contemplated by Dubai World? Dubai has denied that this offer was made but that is not inconsistent with the article which said the offer was under consideration not that it had been made. Also one has to remember the penalties in terms of access and other tragedies that might befall journalists that one would suffer for printing a wholly fictitious story in Dubai about Dubai. Personally I think there must be some truth in the report at least as an indication of the scale of losses the creditors of Dubai World are likely to suffer.

The creditors of Nakheel are likely to do far worse. We won’t have to wait too long to find out how much worse, Nakheel has requested details of its bondholders in case it has to offer a securities swap to them. Well, it will have to because it doesn’t look like it has the capacity to pay them and from the Arabtec work stoppage I think we might be able to infer something about the level of support that Nakheel can expect from Abu Dhabi.

I think the easiest way to try to estimate what is going to happen over the next few months is to try to put yourself in the position of the most powerful actor in the unfolding drama: Abu Dhabi. So it is probably clear to the powers that be in Abu Dhabi that Dubai World is largely insolvent. At the very least Nakheel and Limitless are almost certainly insolvent, and Istithmar probably has negligible positive equity if it were to be liquidated. So whether the value of the Free Zones and DPW is larger than the balance sheet hole in Nakheel (also doubtful) will determine whether there will be much left to pay the creditors of the parent company. It is also possible that Nakheel is seeking information about its bond holders to try to discover whether or not it is likely to be able to secure approval for a securities swap. If enough vulture funds have bought the Sukuk to block a restructuring and force a default in what I think is a vain hope that Abu Dhabi will rescue it again, then they won't even be able to effect the swap. I think it is increasingly likely that the restructuring, if it occurs, is likely to be highly coercive to the creditors and that an outright liquidation is growning more likely.

As far as the foreign creditors are concerned I’m pretty sure no one in the UAE will care very much. Dubai is going to be shut out of international capital markets for some time if only because it’s credibility has been obliterated. Abu Dhabi will still have access but not require it because of its capacity to fund itself. The trouble is that a coercive restructuring of Dubai World has a very good chance of touching off a banking crisis inside the UAE. This is because the balance sheets of ADCB and Emirates NBD will be severely damaged and they may be forced to raise capital. Let’s assume that happens. What will be the next move.

Well, I don’t think that ADCB will have difficulty raising capital or receiving support from the Central Bank given the influence of Abu Dhabi on that institution. What about Emirates NBD? Well, remember Emirates NBD is the largest bank in Dubai and was created in a forced merger between Emirates Bank and the National Bank of Dubai. I remember laughing as I read about it when it was announced because there were no merger terms announced at the time, it was just announced that they were merging. It was clear that Sheikh Mohammed had decided that Dubai needed a banking champion and to create the largest bank he could be compelled the merger between the two largest banks. The CEOs knowing they had to do what the Sheikh told them but not knowing how to go about it simply announced the merger but no terms.

Fast forward to today. The Dubai World crisis is presenting Abu Dhabi with yet another opportunity to strip Dubai of more assets. If you think about if the Sukuk holders force a default, the liquidation of Nakheel would be a bonanza for Abu Dhabi based investors. While any international investor can buy the bonds of Nakheel only GCC nationals can buy the real estate behind them. So in a liquidation sale cash rich GCC nationals (read Abu Dhabi nationals as opposed to Dubai nationals) will be able to scoop real estate from panicked Sukuk holders. I’ll bet you a dollar that when the Dubai World restructuring is announced ADCB and Emirates NBD will both be forced to raise capital. ADCB will receive a combination of aid from ADIA or Aabar and the Central Bank. Emirates NBD on the other hand will be forced to merge FDIC style with a stronger institution based in Abu Dhabi. First Arabtec, then Emirates NBD. Who knows what’s after that?

Telling the future by reading Ben Bernanke's mind.

Ben Bernanke is the Chairman of the Federal Reserve Board and so is the first among equals in setting the monetary policy of the United States. He is also the Shadow Governor of the Peoples Bank of China, the Saudi Arabian Monetary Authority, The Emirati Central Bank, The Hong Kong Monetary Authority, and the Banque du Liban. That is because any country with currency pegged to the US dollar imports US monetary policy. The purists among you will point out that the Renminbi is actually a managed float but if you punch up a graph of it vs. the dollar you will not that it is very managed and not very floating.

So if you live in the United States or any of these other countries or have a relationship with the dollar, (and if you consume petroleum, wear gold, or eat an internationally traded grain, you do) then you have to care about what Ben Bernanke is thinking. He controls the supply of dollars in the world and has a strong influence over the rates at which they are borrowed and lent. So what is he thinking? To answer that we have to take into consideration: first, what is his mandate; second, what kind of guy is he; and third, what makes him get out of bed every day.

Ben Bernanke’s Mandate is to maintain price stability while promoting the maximum sustainable employment in the US.

Bernanke is required to keep inflation low while at the same time promoting substantial economic growth in the US. Note that I say the US. The Chairman has no responsibility to the economies of the nations which peg their currencies to the dollar. This has caused some issues for the Gulf states in the past and is currently exacerbating the concerns of the Chinese government about their economy potentially overheating. Bernanke does not care. He cares about the US and only the US.

Ben Bernanke is a very smart economist, a very creative central banker and has a generally Monetarist outlook.

Ben Bernanke is a Harvard and MIT trained economist who had a successful academic career ultimately chairing the Princeton Economics Department before joining the Federal Reserve. His tenure at the Federal Reserve has been marked by furious activity. The Fed used all of its usual powers such as the discount rate to their maximum extent, then used some that people never thought it would use like quantitative easing and finally Chairman Bernanke invented others like the alphabet soup of liquidity facilities when he felt the need arose. I consider him, and I think he would consider himself, a Monetarist. By a monetarist I mean that he believes that the money supply is one of the most important factors in determining macro-economic performance both in terms of growth rates and inflation. This view has informed his reactions to the crisis thus far.

Ben Bernanke makes more money from royalties on textbooks than he does for being Chairman of the Fed. He gets out of bed every day because he has a real chance of becoming the greatest Central Banker in the history of the world.

This may sound odd because Bernanke has been at the center of the storm over the financial crisis and its aftermath. He is a target for blame because he does bear some responsibility for the origin of the crisis and many of his decisions in its resolution have been controversial. His actions to preserve the financial system have distributed aid unevenly and enriched some who the public believes should be punished. He has been attacked from every point of the political compass indeed the high priestess of Monetarism has practically excommunicated him in an editorial in, of all places, the New York Times.

But to focus on the current press is to miss the larger picture. Bernanke was not the only guy responsible for the financial crisis but he is one of the few who does not have to run for election so a lot of people have sought to shift blame to him. The crisis has had a thousand authors but its resolution was written with a single hand: Bernanke’s. The world financial system was on the edge of collapse and Ben Bernanke brought it back by releasing as much liquidity into the world financial system as if he had broken open a Hoover Dam holding back an ocean of money. When that liquidity hit the markets maybe the wrong people got soaked with cash but the drought was over. This is why he is half way home to being the most successful central banker in the history of the world: people won't remember how he saved the financial system, they'll remember that he saved it.

The other half of it has to with how he soaks up that liquidity. The current holder of the title for best Central Banker in US history now that the Greenspan legacy seems to be as a bubble blower is Paul Volcker. Volcker is famous for killing the great inflation that plagued the US for most of the 1970s by jacking interest rates to the moon in 1980-81. This caused what at the time was the deepest recession since the Depression and put Volcker under massive political pressure but he stood tall, the country took the pain, the inflation subsided and set the stage for a high growth low inflation regime that has lasted almost to this very day. Given the amount of liquidity that Bernanke has poured into the system it is likely he will get the chance to pull a Volcker in addition to is rescue of the financial system.

What does this all mean for what’s ahead?

There has been a ton of speculation in the press and the markets about when the Fed is going to start tightening. There is a lot of concern that Fed tightening is imminent and that if the Fed jumps in too early it will kill the recovery in the crib. If it jumps in too late there will be inflation which, once it gets started is really hard to kill off without a massive recession. Personally I think you can take the three points above to predict what the future holds. Here’s what we know:

1.) Ben Bernanke can go down in history as the greatest central banker ever if and only if he can prevent his massive injection of liquidity from generating significant inflation. To do that he has to begin tightening before the CPI is actually registering inflation. Also as a monetarist, if forced to choose between price stability and employment Bernanke will choose price stability meaning he will risk a deeper recession if necessary to forestall inflation.

2.) Thankfully there is no sign that inflation is even on the horizon so Bernanke is likely to stand pat for a while and let the economy recover. As a monetarist Ben Bernanke believes that inflation is fundamentally a monetary phenomenon. Therefore his signal that inflation is on the horizon is going to be the monetary aggregates, such as M2, which have been stagnant or declining despite the massive amount of liquidity with which he has flooded the system.

3.) So now you know the future because you know what Bernanke is going to do. He is going to sit on his hands and let the loose monetary policy inflate asset prices, repair bank balance sheets, and hopefully stimulate the economy back to recovery before the monetary aggregates turn up. Once M2 starts creeping up, look out because Bernanke will act aggressively to head inflation before it gets going. Once there is more clarity on the Greek situation asset prices in the US dollar bloc have nowhere to go but up until the monetary aggregates turn upwards and Ben Bernanke responds to the bat signal. You heard it here first.

Dubai announces that an announcement about the Dubai World restructuring plan is imminent. And they mean it this time, not like those other times...

When is suspense not suspense? Dubai World has announced that they will have a restructuring plan to present to creditors sometime in March. I have already written on delays in the negotiations and I don’t really want to focus on them too much. This is a lot of smoke and mirrors and the passage of time will bring it all to light because the debts must be paid and the next repayments are only weeks away.

The delays of the restructuring plan have been blamed by the Dubai World on its complex legal structure. Apparently there are over 1,000 legal entities inside Dubai World and the relationship between them and what they are worth it seems is quite a mystery. So much so that the DMCC, was able to walk out of the group altogether apparently with no compensation to the parent for any funds invested or services rendered, at least none that has been disclosed. Personally if I were in the process of walking my company out from its parent company which was at the edge of default I would probably not write a letter to a US judge urging leniency for my mentor who has been convicted of running a ponzi scheme, but then I’m not the CEO of the DMCC. I suppose it helps that the Chairman of the DMCC is the son of the Chairman of Dubai World. Thanks Dad. Creditors? Drop dead.

Dubai is no longer asking for a standstill agreement because they have been able to make interest payments so far. Whether this would be possible without the $800 million or so left over from the last infusion from Abu Dhabi after the Nakheel Sukuk was paid off is left to the imagination of the creditors. So, for that matter, have the eventual terms of the restructuring. There seem to be a lot of options on the table from haircuts to sliding scales of principal payment depending on term structure. Perhaps a debt for equity swap for the Nakheel Sukuk holders, or maybe a general conversion to zero coupon debt at a haircut but with a sovereign guarantee. Interestingly Dubai World says there will be no asset sales until a restructuring has been agreed. The asset sales by Istithmar and DPW don’t count because they’re not part of the restructuring. I don’t know how that can be true, if the creditors of the parent are going to be asked to participate in a restructuring then all the subsidiaries are part of it. Except the ones chaired by the son of the Chairman.

There seems to me to be only one sure thing among all of the various options on the table: losses. Big ones.

My guess is that a big factor in the delay has been the very disturbing realization within Dubai World that the assets that are inside the company are vastly less than the amount of money that is owed. More disturbing still is that it is probably not at all clear where the money went. I can’t really print all the theories about this that people are sending in to my blog email address but it seems that a truly colossal amount of money went into decorating offices and into marketing. Those things do not have great resale value. I’m sure some of it was taken fraudulently but my guess is that the vast majority of it was just spent on the things that gave the illusion of prosperity at the subsidiary companies. Now the investors will have to take the hit.

I realize that I have largely been critical of the powers that be in Dubai but only half the blame for this is theirs. As far as I am concerned there are no innocents in this tale. The creditors bear just as much responsibility. Not for the frauds and the losses but for a lack of diligence. How is it possible that you lend $6 billion to an organization that has over 1000 subsidiaries and when the music stops takes three months just to count them let alone value them. How do you lend money do a company whose structure is so complex that a major subsidiary walks away from the group altogether and you are unsure of your legal right to challenge it? How do you buy the bonds of a company that is carrying a non-existent crescent shaped island on its balance sheet at a valuation of $3.5 billion?


Easy, because it’s only money and its not yours. It belongs to the shareholders and the depositors and for some of the banks, to the taxpayers. But you, the guy making the loan, you get business class trips to Dubai. You get to stay in five star hotels, maybe you get a helicopter tour of the Jebel Ali Port. You get a big orgination fee and you can pay yourself out of that. The last thing you want is real scrutiny of how this all works, the first thing you want is to do it again.

And if you are the end investor why did you invest your money here in the first place? Because you wanted higher returns. How do you get higher returns? You take more risks by lending to organizations where you don’t fully understand what precisely the risks are. What are the risks? The risks are that if the Chairman takes your money and sets his son up in business with it or that your money is spent on office decorations and London billboards praising the company or is spent buying trophy assets at the top of the credit cycle, you’re probably not going to get all your money back. How much will you lose? That’s what we’re going to find out.

The short answer is “A lot.”

A Chicago-Style solution to the Bond Vigilantes: He pulls a knife, you pull a gun, He pays the offer on $1bln of CDS, you hit the bid for $10bln.

In my previous entry I wrote about how CDS have been a useful tool for the Bond Vigilantes who have launched a speculative attack on Greece and through Greece the very concept of the Euro. After a brief relief rally based on the EU meetings last week the Euro is falling off again and the Greco-German bond spread has yet to tighten. It looks as though the Bond Vigilantes may make another run at the beleaguered Greeks in an attempt to push them out of the Euro or to force the hand of the EU.

I would like to make a modest proposal to the Finance Ministers of the EU countries for how to deal with this problem: sell the hell out of Greek sovereign Credit Default Swaps.

Of all the measures that the EU and its member governments have been considering I think this would be the most effective. The first question to ask is what are the things standing in the way of EU action today. I think there are two issues. The first is moral hazard and the second is political will. The moral hazard issue is primarily one of signalling. A direct rescue of Greece sends a message to both the sparring parties within Greece itself as well as to those next in line for speculative attack they don’t really need to come to terms with their fiscal and economic policies because they can rely on a bailout. Interestingly the existence of the possibility of a bailout has the effect of entrenching the parties that need to cooperate in order to prevent one. The other issue is political will. The French and German voters would rather throw Greece out of the Euro System than have to pay for their costs.

So what are the tools that the EU is considering to use to assist Greece? The governments of Germany and France, the only ones really capable of providing aid are quiet on this point. Poland however said that the kinds of assistance that are being considered are loan guarantees and straight cash transfers. These are very blunt instruments. Cash transfers are probably only politically possible in an extreme emergency and perhaps only one for which the Greeks are not demonstrably culpable. The problem with loan guarantees is that they are a blunt instrument. For sure they would lower the borrowing costs to Greece on which the bonds which were guaranteed but they are kind of an all or nothing solution. As such, they would have the effect of delaying the necessity of the Greeks themselves reaching a compromise and might make default more likely. Markets beyond Greece would probably also assume they would be rescued and thus would have similar problems addressing their issues. Thus the EU is damned if it does and damned if it doesn’t.

EU government intervention in the CDS markets I think would be an excellent way to square these circles. CDS purchases require no transfer of principal except in event of default. That is to say the governments involved would not have to write checks to Greece. Rather they would simply be lowering the risk to others of writing those check and they would get paid for the serivce. This would be easier to accomplish politically than straight cash transfers as there would be no outflow from the treasury and no need to use taxpayer funds. Indeed if there were no Greek default this would be a net win for the taxpayers.

The economic effect would be very similar to establishing loan guarantees an intervention in the CDS markets would be much more flexible. The similarity would come from the fact that anyone who bought a Greek CDS would then be able to buy Greek bonds with no risk. This would have the effect of increasing demand for Greek paper and thereby lowering the funding costs for the Greeks and narrowing their deficit. Instead of being on a single issue however the Greek CDS could be used to protect any Greek paper and so might prevent some potential sellers from panicking and would calm the markets more generally. This is one source of flexibility, the other is that once the crisis had passed the governments could simply go out and buy the CDS back with minimal market impact. Withdrawing a loan guarantee would be much more problematic.

Intervention in the CDS markets would also have excellent signalling characteristics. For the parties within Greece the EU governments would maintain their studied ambiguity. CDS intervention is a partial and reversible loan guarantee. The parties within Greece would have some confidence that they were not alone but would not be able to completely rely on the assumption of a bailout. On the other hand for speculators to know that they were being sold insurance against an event that the seller could himself singlehandedly prevent. It would be like God selling you hurricane insurance. This would make the trade of gunning against Greece a massively more risky undertaking. If the intervention were sudden and massive it might have the effect of creating a short squeeze against the speculators and forcing them out of the trade altogether. I'm pretty sure the German government and the ECB are better capitalized than the top fifty hedge funds put together. I think this would have the effect of quelling the speculative attack on Greek debt and would give the Greeks some time for their reforms to work.

Just a modest proposal from www.wallstwtf.com