So... these credit default swap thingies,
they pay out if some credit instrument goes bad, like a bond issue,
and, famously, financial companies buy them as side bets hedges against financial "events", including betting against instruments they are promoting to clients, and deals they have no involvement in at all
and they are not regulated
Soooooo........
countries can play this game also, right?
So, Iceland owes a few $billion or so.
It faces sovereign default in 2011 unless a miracle happens.
CDS spreads right now are about 5-6% for Icelandic bonds, which is huge, yet way too small - 1-20 chance of default? Yeah, right.
So, what Iceland should do is buy some CDS on itself.
And at these prices, might as well double cover. Ah, fuck, might as well cover the debt ten fold, it'd only cost another 50%...
yes, I am assuming the purchase is perturbative, the CDS market is reputed to be few hundred trillion $...
then, y'know, if Iceland should "accidentally" default, for some unpredictable reason, it'd get back what it owed, with a few tens of billions $ extra... pay some goodwill money to the sore creditors, and still be well ahead
Good Times would be back!
Now, you'd have to do this through a front, which could keep it quiet, be big enough for it not to be noticeable, and amoral enough to go in on the deal for a reasonable cut of the profits, commish plus side bet on their own account natch...
Yeah, I'm looking at you GS!
Now, all you need is a slightly naive counterparty, who does this crap all the time, has very deep pockets...
who? who?
Hey, it is a natural move for a small overextended country facing potentially imminent catastrophic natural disasters!
Just remember boys, I'll want a cut!
Good to see that Icelanders still have the gene of financial innovation in them 8-)
Iceland has already de facto defaulted because of the collapse of the currency. Otherwise, has Iceland ever defaulted on external debt since independence? I'm trying to think of other instances where a fully developed country has collapsed into sovereign default. I don't think the book "This time is Different" mentions any instances. Iceland may be setting a scary precedent.
Anyway, I like your idea. Iceland wouldn't be the first entity to hedge itself with CDSs, but I doubt they could build that large of a position without driving up the spreads.
I think Russia defaulted on its loans in the late 90s. Didn't cause the world to collapse. I think I remember hearing rumors that it might do so again.
Can't they just get the UK to agree to be paid in pounds sterling, and then topple that currency too?
Filched from Calculated Risk, they got it from Frankfurter Allgemeine
http://img385.imageshack.us/img385/4479/37590743.png
Sovereign defaults in Europe since 1800.
My vague recollection is that Finland is the only modern state that has always paid all governmental debt in full.
We all know that every country has defaulted, including the US, UK, France, etc., but I think that Iceland will be the first rich, highly developed economy to default since the Great Depression. "This Time is Different" identifies countries that have apparently 'graduated' from serial default, such as the US, UK, Japan, Iceland, and many others, and points out that the post-Depression world hasn't yet seen a country 'reverse-graduate' into serial default.
Craig,
It's funny that you mentioned the Russia default. Though it wouldn't fit my criteria for a fully developed economy, the default did cause a lot of headache here in the US, as Long Term Capital Mgmt. can attest. I think even the New York Fed Reserve Bank was concerned it could cause a collapse of the financial system, or at least that's what the LTCM folks tried to convince them of, in an effort to secure a bail out.
Amazing how history repeats itself.