Credit default swaps have returned to the headlines as European politicians blame the derivatives for exacerbating Greece's economic crisis. This morning, Bloomberg News is reporting that German Chancellor Angela Merkel is calling for urgent regulation of credit default swaps to protect the euro zone countries.
Greece’s political leaders are blaming speculative trading in credit default swaps—CDS—for driving up the cost of borrowing and making Greece’s economic crisis worse.

In the Bloomberg article, Merkel is one of several European leaders that urge regulatory action against CDS. “We’re of the opinion that a quick implementation of actions in the area of CDS has to happen,” Merkel said. Citing “ongoing speculation against euro-region countries,” she called for the “fastest possible” implementation of new rules.

Other European politicians, such as French President Nicolas Sarkozy, have also called for regulations to curb the speculation.
Greek Prime Minister George Papandreou meets with President Obama today and is expected to insist that the U.S. curb speculative trading in CDS. Yesterday in videotaped speech, Papandreou warned that speculative trading in CDS would cause the crisis to spread.

Banks that held Greek bonds used the credit default swaps to protect their exposure to Greece’s fixed income instruments.
But European leaders are saying that not everyone trading the CDS has an underlying exposure and that some are using the CDS to take short-term profits.

Hedge funds and other types of traders use CDS to bet on whether Greece would be able to meet its debt payments or default on its bond payments. According to a New York Times article, published on Feb. 25th, the banks made bets using a CDS index contract, the iTraxx SovX Western Europe index, created by Markit Partners, based on the sovereign debt of 15 countries including Greece and other nations.

As volumes soared in the iTraxx SovX index earlier this year, the cost of insuring Greek debt also rose. “The cost of insuring $10 million of Greek bonds, for instance, rose to more than $400,000 in February, up from $282,000 in early January,” reported the NYTimes. As the index soared, there were concerns that investors would shun buying a new issue of Greek debt.
But last week, the Greek government easily sold more than 5 billion euros ($6.8 billion) of 10-year bonds, because investors expected the other euro zone countries would bail Greece out. But Greece has to pay an interest rate of 6.37 percent, twice the rate on comparable German bonds. Meanwhile, with the prospect of other euro zone neighbors coming to Greece's aide, Bloomberg reported that spreads on the CDS index had narrowed meaning the price of insuring Greek debt had fallen.