The Department of Justice is investigating whether several prominent hedge funds conspired to drive down the value of the euro as the Greek debt crisis left the currency vulnerable to sophisticated trading methods employing credit default swaps and other derivatives.
Likewise, the European Commission yesterday (Wednesday) said it would examine trades in sovereign credit-default swaps (CDS) related to the Greek crisis, which has driven the euro lower and prompted officials to warn hedge funds against trying to profit from the region's debt crisis.
The Justice Department's antitrust division "has opened an investigation into agreements among various hedge funds that trade euro contracts," including contracts to trade euros in the "cash or the derivatives market," a person familiar with the letter told The Wall Street Journal.
In a letter sent last week the Justice Department asked hedge funds to hold onto trading records and e-mails relating to the euro, Bloomberg News reported, citing people who have seen the letter.
The letter requested that the funds "preserve all documents" and electronic communications relating to agreements to trade the euro or communications about agreements to trade currencies, the anonymous source told The Journal.
Recent trading in securities related to the Greek financial crisis has drawn the attention of government officials to hedge funds, banks and other speculators. Some critics claim traders have deepened financial difficulties in Europe by first helping nations hide their debt with CDS and other derivatives, and then profited by driving down the value of the underlying securities.
"It is clear in the current environment, and likely for a long time going forward, any entity that profits from another's misfortune, in this case hedge funds versus Greece and the euro zone, risks being the target of public backlash, or worse, government retaliation," Kirby Daley, a senior strategist in Hong Kong with Newedge Group's prime brokerage business told Bloomberg.
Devaluation on the Menu
On Feb. 8, Executives from some of the hedge funds including SAC Capital Advisors LP, Greenlight Capital Re Ltd. (Nasdaq: GLRE), Soros Fund Management LLC and Paulson & Co., attended an "idea dinner" hosted by New York-based research and brokerage firm Monness, Crespi, Hardt & Co., according to an anonymous source cited by Bloomberg.
One of 23 themes discussed at the dinner was a bet that the euro would fall against the dollar.
In fact, during the dinner at the Townhouse, a Manhattan restaurant, a SAC portfolio manager encouraged other traders to join his firm in going "short," or betting against, the euro, The Journal reported citing people who attended the dinner.
A research note issued shortly after the dinner to hundreds of hedge-fund clients by Monness Crespi summed up the SAC manager's argument without mentioning his name, The Journal reported. The trader argued that the euro is likely to fall to "parity," to the dollar on an exchange basis.
The presenter was very bearish on the euro, believing over time it "could trade between 90 cents and $1.20." With the Eurozone countries facing high deficits and historic spending cuts, the note continued, "the presenter's way to play this is to short the euro."
The size of the bets against the euro is unclear.
Justice Department investigators are likely to examine whether information sharing like what occurred at the Feb. 8 dinner constitutes collusion. Because of the difficulty of proving that firms intentionally sought to act together, collusion charges against Wall Street firms have been rare.
Spokespeople for the hedge funds declined requests from CNBC to comment or didn't return calls. Neil Crespi, President of Monness Crespi couldn't be reached for comment.
Insurance Against Greek Default
Credit default swaps are credit derivative contracts that let banks and hedge funds place bets on whether or not a company, or in this case a country, will default. The CDS buyer makes periodic payments to the seller, and in return receives a payoff if the underlying financial instrument defaults.
The Markit Group of London last year introduced the iTraxx SovX Western Europe index – an index based on CDS that let traders gamble on Greece shortly before the crisis. Critics contend that traders and speculators focus on the index's daily gyrations, and as banks and others rush into these swaps, the cost of insuring Greece's debt rises.
Alarmed by that bearish signal, bond investors then shun Greek bonds, making it harder for the country to borrow.
The end-goal of course would be to drive the nation into a full-scale default and collect.
Speculation using naked CDS, where investors take out insurance on bonds they don't own, may "be very destabilizing," with "costs much greater than the benefits," Nobel laureate Joseph Stiglitz said yesterday in an interview with Bloomberg Television.
"The problem with credit default swaps is that they offer a more efficient way to short a company, or a country, for that matter," Money Morning Contributing Editor Martin Hutchinson said in an interview.
"To sell a share short, you risk all your capital – there's no limit on how high a share of stock can rise. To buy puts, you deal only in a small market, and most puts are short-dated, so you would have to act quickly," he said. "With a CDS, however, you pay only an annual premium that is a small fraction of the principal amount involved, you acquire an asset that typically lasts several years, and you can deal in a market of over $60 billion – enough potential profit for even the greediest hedge fund."
In the wake of the Greek debt crisis, the European Commission has summoned banks and regulators to discuss regulation of the market for sovereign CDS.
The European Union's executive agency will hold a meeting in Brussels "shortly," Chantal Hughes, a commission spokeswoman, said in an e-mailed statement obtained by Bloomberg. The talks, which will take place as soon as March 5, will cover CDS pricing and links to the sovereign bond market, according to three people familiar with the discussions.
The speed of the commission's reaction is "surprising," Karel Lannoo, chief executive of the Centre for European Policy Studies, said in a telephone interview with Bloomberg yesterday. "It's only a week or so that the CDS story has been around."
The commission will meet with national financial supervisors on the morning of March 5 and CDS market participants in the afternoon, according to anonymous sources cited by Bloomberg.
Deutsche Bank AG (NYSE: DB), Germany's biggest bank, will attend the meeting. Deirdre Leahy, a spokeswoman for the International Swaps and Derivatives Association Inc. in New York, declined to immediately comment.
"We are looking at the issue very closely," commission spokeswoman Hughes told Bloomberg. "We need to be vigilant."
News & Related Story Links:
U.S. Said to Tell Hedge Funds to Save Euro Records
- Wall Street Journal:
U.S. Probes Bearish Euro Bets
- Money Morning:
Credit Default Swaps Strike Again – This Time Driving Greece to the Brink of Default
Banks Summoned by EU to Discuss Sovereign CDS