Pure Speculation

The Greek prime minister is laying his country's financial problems at the door of "speculators," or short-term market players who are betting that the Greek economy is likely to default on its massive debt. Never mind that the debt accounts for 12.7 percent of the economy and exceeds the EU debt ceiling of 3 percent of GDP. Never mind that Greece hired Goldman Sachs to use currency swaps to hide the true magnitude of its debt so that it could sell more debt. It's the speculators who need to be brought under control.

Papandreou visited with President Obama today and said that he received a "positive response" when it came to the subject of curbs on market speculators, as proposed by the EU. A White House spokesman sagely avoided the issue by saying the EU should take the lead in dealing with Greece's problems.

The EU is considering a ban on purely speculative swaps. What's that? Well, first of all, credit-default swaps are a form of insurance on bonds issued by companies or governments. The price of the CDS rises as the perceived risk of default rises. One would reasonably assume that most CDS are purchased by bond owners who want protection in the event that the underlying bond goes belly-up. That is not the case, though. Many CDS are bought by hedge funds and other investors who bet purely on the direction of the CDS itself, even though they don't own the underlying credit. In that way, hedge funds that don't own Greek credit can drive up the cost of Greek CDS, which can be a red flag in and of itself, driving up interest rates on the underlying credit.

Whether this sort of speculation is a bad thing is subject to debate. But as a general rule, it is pretty tough for speculators to push the price of an asset too far, for too long, in the wrong direction. There's a rich history of speculators getting burned by wrong-way bets on housing prices, etc.

And given the level of public debt in Greece, the country is wading through the financial markets with a big target on its back.