Global Trends by Martin Khor

Monday 8 March 2010

Financial speculators still causing havoc

The past fortnight has seen new outrage against financial speculators especially the hedge funds that are accused of undermining Greece and the euro.  But will action ever be taken to curb them?


Recently there have been reports on the new speculative activities of hedge funds which are said to have betted against the credit-worthiness of crisis-hit Greece, and against the value of the euro.

Political leaders in Europe are now attacking the role of hedge funds and other financial speculators, while the European Commission is investigating their activities with a view to tighter regulation.

The role of derivatives, and especially the credit default swaps, are also coming under attack, as these are found to be among the most potent speculative instruments.

What is really surprising is that action against the speculators and the mechanisms they use have not yet been taken until now.

It was financial speculation, with the use of instruments such as securitisation of debts and credit derivatives that lay the ground for the Western and global financial crisis that almost torpedoed the world economy.

Despite the enormous harm they have caused, many of the speculators and the instruments have been allowed to continue their trade.

The reason for this, according to many analysts, is that the financial institutions, tycoons and their lobby groups wield enormous influence over political leaders, and partly because of the contributions they make to the political parties, especially in the United States.

In the Asian crisis that started in 1997, Malaysia and Thailand pointed to the hedge funds as a major cause of the speculative bout that caused the collapse of currencies.  Malaysia then highlighted the enormous leverage the hedge funds commanded, that they could borrow 50 dollars for each dollar of capital they had, and this gave them such power to sway and manipulate the markets.

The International Monetary Fund was requested to study the role the hedge funds played, but it  declared their role was minimal, a conclusion reached by not understanding the leverage enjoyed by these institutions and their further power through the use of derivatives.

The speculators were given free rein, and they enormously expanded their activities and range of instruments in the decade following the Asian crisis until the speculation based on securitisation of US mortgages triggered an even bigger crisis.

Unfortunately, the process to reform the financial sector has stalled, and little action has been taken to  discipline the hedge funds and the derivatives.   Thus new manifestations and forms of speculation have now hit Europe when it is in a most vulnerable state.

The hedge funds are now accused of preying on Greece by engaging in the trade in credit default swaps in the expectation that Greece will have problems in meeting its debt payments.

More recently, the hedge funds are said to be short-selling the euro, in the expectation that the crisis in Greece and the weakness of other countries like Spain, Portugal and Ireland would cause the euro to either weaken or even collapse.

The Independent of London reported last week on “gigantic bets against the euro have fuelled rumours of a hedge fund plot to cash in on the Greek crisis” and on “fears of a hedge fund conspiracy to destroy the euro.”

Its 4 March article said the value of the "bets" made by hedge funds and others against the European currency has reached more than $12bn, almost double the amount of a few weeks ago, and the number of credit default swap (CDS) contracts made to the same effect has also soared.

Many CDSs, which are an insurance against the risk of default by a debtor,  have been taken out by those with no ownership of the underlying asset, such as Greek government bonds, in what is termed as "naked" CDS trading.

According to another Independent article:  “CDSs are a type of insurance taken out when an investor is concerned about risk of default. At the moment, for example, the premium to insure 10 million euros of Greek government securities is 428,000 euro. "Naked" shorting via the CDS market takes place where the trader does not own the underlying security, likened to taking out life insurance on other people, with similar homicidal intent.”

It is quite incredible that just a year or two following the near collapse of the world financial system and the pledges made by the leading Western countries to tighten financial regulation, that new forms of speculation and manipulation have been allowed to take place, with such adverse effects in Europe.

Some action is now being explored.  The European Union's new Internal Market Commissioner, Michel Barnier, plans to investigate the short selling of the euro and the abuse of the credit default swaps market.  He has the authority to act as he is now drafting a EC directive on “alternative investment fund managers”, which is supposed to regulate hedge funds and others.

Chairman of the U.K. Financial Services Authority Lord Turner has also criticised naked CDS, saying “there are questions as to whether you should be allowed to take out an insurance contract where you don't have an insurable interest."

Finally, the Greek government banned hedge funds from being allocated any of the 5 billion euros of bonds that it offered last week.  At a meeting in Berlin, the German Chancellor Angela Merkel and Greek premier George Papandireou announced they would push the EU and the G20 to contain  speculative instruments, such as credit default swaps,  especially if the speculation is against states.

Now we have new outstanding examples of financial speculation undermining a country (Greece) and a major currency (the euro), and also new pledges by important political leaders to act against speculators and their instruments.

More than a decade after simpler forms of speculation undermined the currencies and economies of many East Asian countries, and two years after the eruption of the current global crisis, it still remains to be seen if action will be taken to curb the speculative mania.   

Or would it take yet another and more gigantic financial crisis before speculation is finally banned?