Paul Lachine

Democracy or Finance?

"Shorting" sovereign debt is how financial markets hold governments accountable. Ultimately, however, it is voters, not markets, that hold governments to account, and, when these two accounting standards diverge, the popular standard must prevail if democracy is to survive.

LONDON – “Shorting” is a tactic well known among the financial cognoscenti. It means betting against an asset with borrowed money in the expectation of making a profit when its value goes down.

A speculator can “short” a government by borrowing its debt at its current price, in the hope of selling it later at a lower price and pocketing the difference. For example: on January 1, 2010, I think to myself that the game will soon be up for the Greeks. I borrow, at face value, €10 million of the Greek government’s 2016 bond, which is then trading at €0.91, from Goldman Sachs for six months. For this, I have to pay Goldman Sachs the yield that it would receive from the bond – around 5% annually at that price, so about 2.5%, or €250,000 – during the six-month term.

I immediately sell that bond in the market, for €0.91, so I get € 9.1 million (€0.91 x €10 million at face value). Fortunately, my bearish view comes to fruition in May, when the full extent of the country’s fiscal problems becomes clear. By June 30, when I am due to return the €10 million in face-value Greek 2016 bonds to Goldman Sachs, the bond is trading at only around €0.72. So I go into the market, buy €10 million at face value for at €0.72, or €7.2 million, and return the bond certificates to Goldman Sachs as per our agreement.

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