Greece outside the euro: a sad scenario. Part 4

Professor Blythe, believes credit default swaps, complex financial instruments invented after the infamous 2008 financial crisis, will give the green light to a crisis in America.

Swaps were created as a kind of credit insurance. After loan money is allocated to a business or government, investors take out credit insurance. If the borrower runs into difficulties and cannot pay (e.g., the Spanish government), the banks that sold the insurance cover the loss.
The hedge fund managed by JPMorgan Chase is the second largest of its kind in the United States. This bank's $2 billion loss in May has hedging roots in Europe. This example shows how easily the most trusted and secure investment banks can go wrong.
If traders believe that other countries will follow Greece's lead, they will raise borrowing rates by selling government bonds (bond yields will increase), pushing up the cost of insuring their debts.
There will be a turnaround in the futures market, where credit-default swaps are traded. Those who have insurance on Spanish debt (where bad debts are on the rise) will force the banks that trade such swaps to prove their solvency. To do so, the banks will need additional cash - U.S. government debt, gold, or something easy to sell. In normal times, this is no big deal. In a crisis, it could lead to a cascade of sales, spreading the epidemic from one market to another. Another problem: it is not yet clear how much money U.S. banks are transferring to Europe via credit default swaps, since the rules allow banks to keep this information secret.
There are other ways for the crisis to penetrate the United States.
Mutual money market funds, covering more than $2.5 trillion, have about 15 percent of their investments in Europe. European banks are also big buyers of U.S. mortgage bonds. If they are forced to sell them, mortgage rates will rise, endangering the U.S. housing market. Frightened banks could also pull up the credit lines of companies, which in turn depend on global trade.
Analysts at Barclays Capita have tried to assess the consequences of such a scenario. They compare it to the consequences when the Lehman Brothers investment bank collapsed in September 2008. This time, the price of oil would fall to $ 50, stock markets outside Europe would fall 30 percent, and the dollar would rise and equalize with the euro. Blythe doesn't really believe this will happen because he hopes the previous financial crisis taught governments and central banks something.
Nevertheless, the Greek story will end, Blythe believes, with a bad ending. Uniting 17 countries with a single currency worked well when Europe was thriving. Now that they are at odds, "all the design flaws become apparent," he says. Every step taken that is supposed to solve a problem creates another problem. For example, the $125 billion in loans to save Spanish banks adds to the debt burden of Spain and other troubled European countries, which are spending more and more on loan repayments, putting their already strained budgets in jeopardy.
"The Euro now," concludes Blythe, "is a bloody doomsday machine.

Based on foreign press for ForTrader.org