Greece is in financial trouble -- and that's creating winners and losers. The losers are the Greek people, who are suffering from the government's austerity measures so Greece can show a more balanced budget -- and perhaps get bailed out by wealthier EU members.

Holders of Greek debt could also suffer if Greece defaults. That is, unless you happen to be a big bank or other institutional investor who has bought a credit default swap to offset any loss incurred should Greece actually default on its sovereign debt. But Goldman Sachs Group (GS) -- which has used such credit insurance to bet against Greek debt and earlier helped mask Greece's debt problems -- could come out as a winner. And that has caught the eye of Fed Chairman Ben Bernanke.

To put this situation in perspective, at $300 billion, Greece's debt is about 2.5% of the U.S.'s $12 trillion debt. The three biggest holders of Greek debt are banks in France ($75.4 billion), Switzerland ($64 billion) and Germany ($43.2 billion), according to The New York Times.

Rising Prices to Insure Against a Greek Default

Here's where the credit default swap (CDS) -- comes into play. A CDS is an insurance-like contract that obligates the CDS seller to pay the CDS buyer a set amount upon a bond issuer's default. A CDS buyer is often a holder of the debt that the CDS "references," but not necessarily. A CDS buyer also can simply be betting that a particular bond issuer, like Greece, will default. If the issuer does default, the CDS holder reaps its payment from the CDS seller, whether it holds the actual bonds or not.

And the Times reports that as Greece's financial situation has deteriorated, the amount of outstanding CDSs on Greek debt has skyrocketed by 124% from $38 billion a year ago to $85 billion this month. The increasing risks of Greece defaulting on its debt has pushed up the price to insure $10 million of Greek bonds 42%, from $282,000 in early January to more than $400,000 in February, according to the paper.

The CDS market has proved profitable for many U.S. and European banks. For instance, when American International Group (AIG) failed in 2008, the U.S. government made good on billions of CDSs that AIG had written, to the tune of 100 cents on the dollar. Among the banks that got their CDS payments this way were Europe's Société Générale (which got $11.9 billion from the U.S. payout), Deutsche Bank (which got $11.8 billion), UBS ($5 billion) and BNP Paribas ($4.9 billion). Goldman Sachs ($12.9 billion) was among the U.S. beneficiaries of this backdoor bailout.

Now, some of these same European banks could profit from a Greek bond default via CDS payouts. Switzerland's Credit Suisse and UBS, France's Société Générale and BNP Paribas and Germany's Deutsche Bank are said to be big CDS players -- although the The New York Times's anonymous sources didn't reveal whether these banks hold CDSs against a default in Greek bonds.

A Downgrade Coming?

With Moody's (MCO) now threatening a downgrade of Greek debt, the only things that could save Greek bondholders would be a credible plan to cut the Greek budget deficit by 4 percentage points to 8.7% in 2010, according to, or an EU bailout.

However, the Greek austerity plan is unlikely to go through because it's politically toxic. Greek citizens are striking (pictured) and protesting the measures needed to achieve those budget targets, which says include increases in the country's value-added tax, fuel tax and duties on luxury goods, in addition to more cuts in civil servants' pay. Absent such cuts, Moody's could downgrade Greek debt two notches from A2 to A4.

The whole situation raises questions about the role of CDSs here. For example, is Goldman Sachs helping make Greece's debt problem worse -- through its earlier efforts to obscure Greece's true indebtedness -- even as it's now prepared to profit from a Greek default through its CDS buys? And are the banks that hold Greece's debt really going to lose if it defaults, or do they hold CDSs on those bonds that will protect them, or even profit?

The world deserves answers.

Peter Cohan owns AIG shares, but has no financial interest in the other securities mentioned.

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I think you have to seriosuly consider who is backing the CDS? I know that insurance companies are required to keep large reserves when they do business and are regulated by U.S. states. But who regulates the companies selling the CDS to make sure that these firms have cash to pay out claims. And I am just curious as to why anyone with legitimate reserves would have sold CDS in the past year considering the known risk of default. Basically, you have to consider whether anyone reckless enough to sell the CDS would actually have the cash reserves to back those CDS in case of a default.

May 13 2011 at 2:52 PM Report abuse rate up rate down Reply

Who the hell is going to pay $85 billion in CDS claims? What idiotic institution would back the CDS? I am still ticked off about the government backdoor bailout of Goldman Sachs, Deutsche Bank and others through the AGI bailout. My attitude is don't pay.

May 13 2011 at 2:43 PM Report abuse rate up rate down Reply