If European nations start defaulting, then the U.S. is in a lot of trouble – no matter what Ben Bernanke and Tim Geithner say to the contrary. That’s why Bernanke and Geithner are among those doing what they can to make sure this doesn’t happen. But there’s a powerful group that wouldn't mind a default: Hedge funds. They want it for a powerful reason. It’s the only way they’re going to make a profit on their all that Greek debt they bought at steep discount.

Even though I have been saying “EUROPE IS GOING TO EXPLODE!” for a long time, I have to admit there is some small amount of hope right now. The EU appears to be almost, kind-of teetering on the edge of starting the process of beginning to come up with a plan for its debt problems. I’m not holding my breath, but there are some good signs. Among them: Spain and Italy paying a lot less to borrow, which means they are less likely to default. Unfortunately, neither one is the nation of greatest concern to the hedge fund managers. That honor goes to Greece.

There is no good news about Greece. It is bankrupt and would be totally unable to pay its bills were it not for handouts from the European Central Bank and the IMF. In order to get someone to loan it money, Athens is paying 34 percent on a 10 year note and 403 percent (that is not a typo) on a 1 year note (and they still can’t find buyers). The only reason it has not already defaulted is because of some linguistic slight-of-hand put in place to give the EU and the Greeks time to negotiate with the creditors.

Right now a lot of people and companies who loaned Greece money are resigned to the fact that they are going to get at most 50 percent of their money back. The financial euphemism for this is “taking a haircut.” This haircut will leave more skull than scalp. Greece would still be in financial trouble even if 100 percent of its debt was forgiven. So why then are a bunch of hedge funds insisting they want all their money back?

Because if the debtors don’t voluntarily agree to this haircut, Greece will officially be in default. Once that happens the bond holders can collect all their money – not from the people of Greece, but from the firms which have Credit Default Swaps on all this debt. That is why a bunch of hedge funds have actually been going out and buying as much Greek debt as they can (and believe me, it’s a buyer’s market). As Bloomberg reports:

Saba Capital Management LP, founded by former Deutsche Bank AG (DBK) credit trader Boaz Weinstein, York Capital Management LP, the $14 billion fund started by Jamie Diman, and London-based CapeView Capital LLP are among managers that now hold Greek bonds. … If Greece refuses to pay the funds what’s owed to them, the funds may seek to trigger the credit-default swaps. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

The theory is based on the idea that these other entities have the money to pay off the CDSs. They don’t. They have some money and a lot of loans out on bonds and properties of questionable value from other European banks. They will have to call in those loans in order to pay off the CDSs. This will require other banks to call in loans and sell assets in order to pay what they owe. Lather, rinse, repeat until who knows when. Remember 2008 and our barely-averted financial meltdown? Like that, only on an international scale. All so some funds can get the face value of debt they bought at a tremendous discount.

Ain’t high finance grand?