Difficult Risk – Risk Tradeoffs: Political vs. Financial Risk in the EU

There was an important article by Jack Ewing and Liz Alderman in the August 10 edition of The New York Times, thumb entitled “Some in Germany want Greece to temporarily exit the Euro Zone.” This article takes up issues that have been quietly heating up in the background for some time already but which are, cialis inevitably, becoming harder to ignore. Ever since the first EU bailout of Greece in May 2010, and intensifying with the subsequent Portuguese rescue mission and especially the second Greek one, both in 2011, comments emanating from Germany and elsewhere have cast aspersions on the “profligate southerners” who have come to depend on their “frugal” northern compatriots to rescue them from financial disasters of their own making.

Full article: Risk Risk Tradeoffs [PDF]

Financial Risk: The World turned Upside Down

Image courtesy PIAZZA del POPOLO / Flickr

Here’s the latest from the Greek debt crisis:

“Europe is seeking to avoid a default at all cost because it could also initiate payment of credit-default swaps, there with unpredictable results. There is little public information on which financial institutions have sold credit-default swaps and might have to absorb losses if Greece defaulted, there but it is likely that American banks and insurance companies have taken on the largest share. The shock to the global economy might compare to the collapse of Lehman Brothers in 2008, illness the European Central Bank has warned.” (Jack Ewing & Landon Thomas Jr., “Europe faces tough road on effort to ease Greek debt,” The New York Times, 4 July 2011)

Wait a minute! In credit default swaps the first party pays a premium to a second party in order to “insure” the value of an amount invested in corporate or government bonds made by the first, and the second party guarantees to make up the shortfall if that investment loses value, for example where the issuers of the bonds default on their debt.* Derivatives such as credit default swaps are a risk management strategy for investors, protecting them (for a price) against large losses. So how does this very sensible risk mitigation strategy, used by individual investors, end up causing or exacerbating another broad financial crisis?

The World turned Upside Down