Wall Street loves a piñata party – singling out a company or country, making it the 

piñata, grabbing their sticks and banging it until it breaks. As in the child’s game, the 

piñata is left in shreds. Unlike the child’s game, in the Wall Street version the piñata 

is stuffed with money for the bankers to scoop up with both hands, instead of 

sweets. We see this game being played today, with Greece as the piñata. 

Investors trying to understand why their portfolios have begun to melt down for the 

second time in five years are becoming experts in the fiscal policy of Greece. A look 

at the piñata party might make things clearer. 

Greece’s travails are often measured by reference to the market in credit default 

swaps (CDS), a kind of insurance against default by Greece. As with any insurance, 

greater risks entail higher prices to buy the protection. But what happens if the price 

of insurance is no longer anchored to the underlying risk? 

When we look behind CDS prices, we don’t see an objective measure of the public 

finances of Greece, but something very different. Sellers are typically pension funds 

looking to earn an “insurance” premium and buyers are often hedge funds looking to 

make a quick turn. In the middle you have Goldman Sachs or another large bank 

booking a fat spread. 

Now the piñata party begins. Banks grab their sticks and start pounding thinly traded 

Greek bonds and pushing out the spread between Greek and the benchmark 

German CDS price. Step two is a call on the pension funds to put up more margin, or 

security, as the price has moved in favour of the buyer. The margin money is 

shovelled to the hedge funds, which enjoy the cash and paper profits and the 20 per 

cent performance fees that follow. How convenient when this happens in December 

in time for the annual accounts, as was recently the case. This dynamic of pushing 

out spreads and calling in margin is the same one that played out at Long-Term 

Capital Management in 1998 and AIG in 2008 and it is happening again, this time in 

Europe. 

Eventually the money flow will be reversed, when a bail-out is announced, but in the 

meantime pension funds earn premium, banks earn spreads, hedge funds earn fees 

and everyone’s a winner – except the hapless hedge fund investors, who suffer the 

fees on fleeting performance, and the unfortunate inhabitants of the piñata. What 

does any of this have to do with Greece? Very little. It is not much more than a 

floating craps game in an alley off Wall Street. 

This is where the idea of CDS as insurance breaks down. For over 250 years, 

insurance markets have required buyers to have an insurable interest; another name 

for skin in the game. Your neighbour cannot buy insurance on your house because 

they have no insurable interest in it. Such insurance is considered unhealthy 

because it would cause the neighbour to want your house to burn down – and 

maybe even light the match. 

When the CDS market started in the 1990s the whiz-kid inventors neglected the 

concept of insurable interest. Anyone could bet on anything, creating a perverse wish 

for the failure of companies and countries by those holding side bets but having no 

interest in the underlying bonds or enterprises. We have given Wall Street huge 

incentives to burn down your house. 

Let’s be clear, public finance in Greece is a mess. Statistics have been fudged, 

government pensions have been inflated and reckless borrowing has been the norm. 

Drastic remedies are required. But the crisis is manageable, and Europe has sent 

clear signals that they will take care of their own house without help from China, 

America or the International Monetary Fund. Unfortunately, a measured response 

does no good to the dealers in CDS, who require volatility and even panic to make 

their game a profitable one. If contagion spreads in uncontrollable ways, so much the 

better for the traders in volatility, never mind the collateral damage. 

Until the CDS market is confined to buyers who have an underlying interest in the 

risk being covered, and sellers who are regulated as insurance companies with 

adequate reserves, this market will remain a reckless enterprise bent on arson. 

Serious issues of sovereignty and stability are at stake. Regulators have to stop 

ignoring the piñata party and start providing adult supervision. 

James G. Rickards is a writer, lawyer and economist and the former General Counsel of Long-Term Capital Management. Mr. Rickards holds an LL.M. (Taxation) from the New York University School of Law; a J.D. from the University of Pennsylvania Law School; an M.A. in international economics from the School of Advanced International Studies, Washington DC; and a B.A. degree with honors from the School of Arts & Sciences of The Johns Hopkins University. He can be contacted at james.rickards@gmail.com, and on Twitter at @JamesGRickards [1].

URLs in this post: [1] @JamesGRickards: http://www.twitter.com/JamesGRickards

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