Montreal, Canada

George Soros wants them banned. And now several European governments want to banish them, too.

Credit default swaps, or CDS's, are in the firing line this month as critics of the trade hammer down on banks and hedge funds amassing big bets against Greek and other weak sovereign government bond markets. The Greek government is also coming under fire for its 2001 arrangement with Goldman Sachs for structuring swap contracts that might have resulted in obscuring Greece's fiscal woes.

Some hedge funds, fearing a government and public backlash, have exited the popular trade altogether in February. Instead, some traders are betting against the EUR and buying gold, a trade that might produce big gains if Greece defaults.

Specifically, credit default swaps allow speculators to wage a bet against a borrowers' credit worthiness. Basically, these instruments act like an insurance-like policy whereby the prices of certain swaps will rise or fall depending on the markets' perception of creditworthiness of that borrower. Investors can bet against issuers at the government and corporate levels.

Lately, institutions have been gobbling-up Greek credit swaps on bets the country will either default or pay a much higher premium to secure debt-financing.

In 2010, Greece will require more than €50 billion EUR, or $68 billion dollars, to plug its gaping public finances; According to the Greek government, Greece's public debt as of October 21, 2009 was €272.3 billion EUR, or $370 billion dollars, equal to 113.4% of its GDP. Outside of official Greek numbers that figure is probably much higher.

The likelihood that Greece will default, however, remains remote. The International Monetary Fund, or IMF, has a standby loan facility of €30 billion EUR, or $41 billion dollars, just in case Greece comes calling. It's unlikely the ECB, or European Central Bank, will hand out a blank check to Greece without IMF support, which comes with harsh austerity terms.

The last thing Greece needs is austerity in the midst of struggling credit intermediation.

A big cut in government spending, demanded by the ECB and the IMF, will inject a massive dose of deflation into the real economy. Though there's no way for Greece to avoid fiscal discipline, a promise to reduce state spending by 50% or more over the next few years will probably do more harm than good as wages, GDP and the public sector shrink further.

Maybe Greece should exit the single currency and bring back the drachma. This might be the only viable solution for the battered EMU nation because austerity measures won't help the economy any time soon while the populace grows more militant by the day at the prospect of a major cut in state spending.

Credit default swaps might face extinction in the age of violent credit markets and government efforts to stave-off a financial meltdown in sovereign borrowing limits, which now dwarf corporate bond issuance since 2009.

When government perceives the free market as lopsided it simply changes the game. We saw that in 2008, as short sellers in several countries were limited or banned for months amid a protracted global bear market. Now, credit swaps are being targeted. The odds are high that credit default swaps will be banned this year.

I'm off to FX University tonight in Scottsdale, Arizona. I will blog tomorrow and Dugald will be blogging about the technical picture on Wednesday. I'll be back next Monday. Have a good week.