Bears in bull disguise prowl the eurozone

Forget the elephant, there is a great big bear in the room - and in the china shop, for that matter. There in the shadows, while Sarkozy and Merkel try their best to tune them out, the bears are primed and ready to crash the debt-market party.

For all the past year's waffle about saving the eurozone, it really boils down to limiting the losses private-sector banks might make - and instead transfer the debt to the public and try to recoup it through higher taxes, job cuts and reduced social benefits.

The Germans and French know all too well how badly exposed European (and US) financial institutions are to the sovereign debt of Greece, Spain, Portugal and Italy. That is why at today's crunch meeting they'll once again be pussyfooting around the issue of "haircuts" - how much banks can afford to lose without supposedly bringing down the entire global market.

That these wretched banks walked into the sovereign debt deals (buying fat-yielding bonds from bankrupt governments) with their eyes wide open, and now stand with the begging bowl, is what drives the rest of us batty.

There is another matter that should make your eyes roll, and it concerns the loitering bears mentioned at the outset.

You may remember that the likes of Goldman Sachs and JP Morgan turned out to be the big winners in the 2007/8 credit meltdown - mainly because they were craven enough to play both sides of the market: selling sub-junk collateralised debt obligations to third parties at the same time as betting on the imminent demise of the very same instruments.

They made out like bandits, and you can be sure the two bogeymen weren't alone in their devious double-dealings. Every major US and European bank - by the very fact they're still alive today - must have bought insurance against their investments in sub-prime mortgages going phut.

Fast-forward to today. Realistically, do you think it is possible that the big banks have not insured themselves to the hilt against the possibility that their loans to sovereign basket cases might never be paid back? Fat chance.

So the very people purportedly most at risk of going under are first in line to make a killing.

There is nothing even remotely illegal or opaque about all this, it must be said. Credit default swaps (CDS), tailored as much for their hedging value as for bearish short punts, are tightly policed by the International Swaps and Derivatives Association.

Understandably, the association has been under a lot of scrutiny of late: its members are likely to be the only ones left standing when southern Europe eventually collapses.

The industry body's website http://isda.derivativiews.org is well worth a visit. In recent weeks, the ISDA has been at pains to explain just how harmless its CDS activities are. From the outside, however, it looks terrifying.

For instance: "There are only 10 trades a day in actively traded entities globally, four in less frequently traded entities and less than one trade per day in the infrequent entities."

That means a lot of illiquid money tied up in some very big bear positions. How big?

"In the single-name market, the average size trade for corporate CDS denominated in US dollars is $6.7-million and for euro-denominated CDS it's à5.9-million. Sovereign average size is $16.7-million and à12.5-million. Five percent of US dollar corporate trades are $20-million or higher while the same figure for sovereign CDS is $50-million and à50-million."

(A single-name CDS is defined by Investopedia as one in which the underlying asset or reference obligation is a bond of one particular issuer or reference entity. Like Greece.)

A New York Federal Reserve report in September found that there are only 50 to 100 participants trading daily in single-name CDS.

Meet the new bosses, the same as the old bosses ...