It was only a matter of time before the banks would create wagers against states such as California, New York, and Michigan. The latest derivatives are called municipal credit default swaps. JP Morgan Chase and Citibank are both offering these bets against the states and other municipalities. The problem with these derivatives and any other similar instrument, is that they are unregulated and are only as good as the capital of the entity on the other side of the transaction- similar to a bet. If the bookie accepts a bet with a person, he expects to be paid if he wins. Otherwise, he sends his “enforcer” to collect. These banks continue to play with taxpayer money since they would once again be bailed out if they lose too much capital. Betting against California’s ability to repay a municipal bond is no different than betting on tomorrow’s basketball game, only the stakes are higher. Any increase in price of these derivatives will signal to bond traders to demand higher interest rates for these bonds thus creating a death spiral. California’s woes are greater than Greece but most of the focus has been in Europe until now.
See: http://www.huffingtonpost.com/2010/04/27/banks-bet-against-us-citi_n_553891.html
When greed is left unchecked, financial chaos will ultimately prevail. Only by changing the law will banks no longer “double dip” by both selling municipal bonds and derivatives that promote the default of the very same bonds.