Free The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE by Faisal Islam

adviser James Carville who mused that in a future life he’d want to return as a trader in government bonds. ‘You can intimidate everybody,’ he chuckled. The term ‘bond vigilante’ was coined by the US economist Ed Yardeni in 1983 to describe traders who would sell off the debt and demand higher yields (averaging 11 per cent) to compensate for the perceived risk of higher inflation and higher deficits in President Reagan’s America. The bond vigilantes were unleashed again on President Clinton, when in 1993 he introduced his wife’s plan for extra health-care spending (‘HillaryCare’), and ten-year US Treasury bond yields shot up to 8 per cent. HillaryCare was parked as US politicians baulked at rising mortgage and business lending rates (which tended to go up if government rates went up).
    At the midtown New York offices of capital markets investment bank Cantor Fitzgerald, one of America’s busiest bond trading floors, Brian Edmonds eyes banks of computer screens. Edmonds is the firm’s head of interest rates, and its star bond trader. It’s not just the economic data he’s interested in, but also the deluge of political dysfunction from Washington DC to Frankfurt and Athens. He deals in dollars, euros, yen – any currency that’s doled out by the billion-load to the world’s debtor nations, for a price. This and other trading floors like it are where capital markets trump capital cities. The total size of the global bond market is $78 trillion, and half of this comprises government bonds. The USA and Japan alone make up over half of the world’s outstanding government bonds. The markets are large and liquid, with thousands of global players constantly trading electronically.
    It was August 2011 when I visited Cantor Fitzgerald. It was during a historically turbulent week, when the USA lost its AAA credit rating. Intriguingly, Washington and London were being treated far more kindly than Paris, Athens or Dublin. I asked Brian what the impact had been on US Treasury bonds. ‘Positive,’ he said. Would a European sovereign get the same treatment? ‘I don’t think so. In the USA we still have our own currency, and if you look at full faith and credit of the USA, we still have the ability to pay the debt.’ By 2011 US bond traders were a little more understanding of the deficits of their government than their predecessors had been in the 1980s and 1990s.
    By the time of the crisis, James Carville’s reincarnation of choice would have moved from the large investment-bank bond trading floors to the smaller trade in credit default swaps (CDSs) at a small hedge fund. CDSs had become an instrument to take a view in debt markets that previously would have required buying and selling a bond. The prices and market insight from CDSs were very helpful for regulators and central banks as measures of market default risk – and they were more quantitative and timely than the rankings of the credit-rating agencies. At the same time, CDSs were, and are, on the face of it, an insane gambling machine, used for speculative attack on banks and nation-states. They were almost completely unregulated. They had only relatively recently become legal. Before the crisis, the presumption had been that government credit risk in the Eurozone did not exist. But CDSs provided the weapon – and dithering in Europe provided an opening – for US and UK speculators and traders to make a killing.
    ‘I can make profits of five to seven times the cash I put up,’ says a hedge fund trader with whom I spent a day. ‘It’s a much more attractive return than buying an actual bond. CDS is a leveraged product, that’s why it grew so much.’ While we talk, various titbits of European political news are dripping through on the financial newswires. Of particular interest is the meeting between the Cypriot president and Angela Merkel. The hedge fund’s principal is trying to work out how Cyprus will be treated by Germany, and its