Sunday, February 14, 2010

Insurable Interest And CDS

The Greek debt crisis is a perfect example of what is wrong with the Credit Default Swaps market. As I have said many times previously, starting in 2007, CDS are not real swaps (as in forward FX swaps or interest rate swaps) but insurance contracts. (I am more than suspicious that Wall Street and The City came up with this obviously misleading name in order to avoid regulation from the staid and conservative insurance regulators.)

AND... as this very good article in the Financial Times makes clear, everyone in the CDS market plays with fire without having any insurable interest in the underlying credit risk (i.e. without owning the bonds). The FT writer says it succintly: "We have given Wall Street huge incentives to burn down your house".

The "arsonists" are to be found everywhere in our investment community (a better term would be juvenile delinquent gang) and they are profiting mightily: pension funds make hefty premiums from selling CDS, investment banks make fat profits by "making markets" ( e.g. Greek CDS commonly have 20 bp bid-offer spreads) and by attacking bonds directly, hedge funds make a quick buck by buying and selling CDS. Happy times everywhere, except for the poor people who have to foot the bill in the end, i.e. those who have to borrow.

This utter nonsense has got to stop NOW. Global regulators can do this with two strokes of a pen:
  1. You want to sell CDS? Fine - you must become a regulated insurance company with adequate segragated reserves, actuarial departments, etc.
  2. You want to buy CDS? Fine - show proof of insurable interest, i.e. you must own the underlying bonds.


  1. CDS are more tightly correlated to equity prices than to bonds. since governments do not have equity, this is a mere fantasy sports game for gamblers.

  2. It's a CDS because it involves swapping credit default risk.

    You're also trying to impose a US centric view of the world and US centric laws on everyone else. Tough, the rest of the world might decide not to accept it.

    As for the trading is Greek default risk, CDS just shows the risk. They are basically bust. As are the other PIGS.

    Even being British, I can tell you that the UK is line too. The government finances are worse than the Greeks.

    Eventually it will spread to the US. You're deficit is huge, and you have to include all of medicine and social security that runs as a ponzi scheme too.

    It's all down to people starting to realize that the western government ponzi set up of take the money now and spend it versus promises of benefits later has run its course.

    The real question is then how one protects oneself, and hence your nearest and dearest against this catastrophe.

  3. A dense question to hellasious,

    Why are so few people posting this plain obvious stuff? Decades of "Neo-con" academic intoxication?

    Your local old-style rural and parochial Beret-Baguette Rueff-ian économiste

  4. Answer to Marin :
    Why are so few people posting this ?
    Because too many people are getting lost in the fine print.
    Specialization has made it difficult for people to step back and take a GLOBAL look at the larger picture.
    Compartimentalization keeps everyone in her/his little box, nose to the page, dutifully sharpening pencils (or punching keys on a computer...) to shuffle numbers around from one column to the next.
    When you spend your WHOLE day shuffling those numbers, how much TIME do you have to indulge in that greatest regulator of all... PHILOSOPHY ?
    And when you live in a culture that shits on the liberal arts/humanities, just WHO, pray tell, is going to do your thinking for you ?
    The truth is... MONEY, (and all these "instruments" as you call them), is a really complicated idea with lots of implications for the way that we look at the world, and the way we act in it.
    We are condemned to look at the larger picture from a philosophical and historical standpoint (as Hell does..) in order to understand the way things work NOW, don't even mention how we would LIKE them to work.
    We have been imagining for way too long that..
    the NUMBERS really have something to say to us.
    We have been looking for meaning in the WRONG places. (or rather we have been looking for meaning ONLY in those places)
    As an answer to Nick, who I find to be a real illustration of my previous comments here about the fear of declassement I might say that...
    I have never felt less fear than I do these days.
    Even with a literature diploma.
    I will survive, as someone said back there...

  5. Clearly, reform is undesirable.

  6. Hell, When you are criticizing CDS market for profligacy by government, aren't you making the same mistake as blaming those holding shorts for problems of Bear Stearns and Lehman? CDSs are not causing Greek defaults. It is the Greek government who is primarily responsible.

  7. It seems like a reasonable suggestion you are making.

    I do have a question however. If I read your article correctly, it is saying that the hedge fund investor is the one who will be taken to the cleaners on this issue in the end.

    I am not totally sure I understand the argument as to why we need to pull funds from school budgets or to fund positions for people whose sole job is to protect hedge fund investors from their own stupidity.

    Or are there other people who are losing out in this mania tat this article does not address, other than all of us for wasting valuable resources and talent on such frivolous activities in the first place?

    Sorry I am missing something here

  8. CDS ban will happen probably in the next 2 weeks. Any other ban on price docovery that has not been tried as yet? Any ideas please submit to SEC and Eurozone for consideration.

    Banana Republics, get on the boat!

  9. Hey, was everybody out w(h)ining and dining yesterday ?
    Or was it another one of those American holidays that I have lost track of ?
    So little activity on this blog, compared to usual ??
    Where are y'all HIDING ? Come out of the bushes and PLAY !!!

  10. President's day - holiday.

  11. an interesting perspective on 'bankrupt' greece:

  12. Nick:

    The U.S. has it's own Greece. The great state of California is bankrupt and represents some 13% of U.S. GDP. California isn't the only state in trouble, but it is the largest.

    Our two countries seem to be in a race towards the edge of the cliff.

    Can anybody tell me what would happen should multiple countries default on their debt at the same time (or close to the same time)? I'm not talking about smaller countries like Iceland or Greece, but major economic powers such as the UK, the US, Germany or Japan.

  13. Re: "Can anybody tell me what would happen should multiple countries default on their debt at the same time (or close to the same time)?"

    I have wondered the same thing and really have no idea but mo worthless 2 cents would be that the elderly would get screwed and the young would do well and the younger one is the better off they would be. World population would grow more rapidly and mortality rates for the elderly would increase.

    Anyone have any other predictions?

  14. "I will survive, as someone said back there..."

    Gloria Gaynor

    "Anyone have any other predictions?"

    Yeah, if the route of Joseph Dhu Nuwas Street had followed a fractal pattern you would be on Google Maps looking it up now but alas, what's 20 KrispyK between friends. Nighty Night.

  15. I read the David McWilliams post.
    Some things to keep in mind :
    There is a slick fascist attempt to ram language unification down all of our throats, but it is with a stick, and NOT a carrot.
    And it is happening at the same time as there is renewed interest in regional dialects, and the French language itself.
    While I think that the EU at this time IS basically an EMU, I also think that the generation that picked up the pieces after WW2, and its children STILL have idealistic hopes that the Union will prevent another... DERAPAGE like what we saw from 1939-45. That our agressive impulses will find more acceptable outlets in the.. ECONOMIC war...
    This is a powerful motivation/incentive for political union.
    But... it is undermined by the upcoming generation's inevitable unconnectedness with WW2. The upcoming generation has only... heard third generation stories, it has NOT experienced the INCREDIBLE DISCOMFORT of a war/occupation on its soil.
    And it is feeling first hand the result of the economic war...
    As for dominos... THAT OLD THEORY STILL AT WORK ?? Esthetically it is BEAUTIFUL, BUT... do things ALWAYS work that way ? Since when was life obliged to conform to esthetics ??
    Yoyo, you are PRICELESS ! lol

  16. Re: "Can anybody tell me what would happen should multiple countries default on their debt at the same time (or close to the same time)?"

    My guess?

    A major deflationary depression.

  17. "It is also time for the U.S. to realize that it can no longer dominate Asia, and that, in its efforts to maintain its former status as top dog in the region, it has exacerbated tensions between a number of countries in the area, tensions that have the potential to produce catastrophic consequences."

    China and India
    A Danger in Thin Air

  18. Totally off topic, sorry, but Yoyo, did you read the 2/4 article in Counterpunch about the invention of the Jewish people ? Breathtaking...
    It would be good if there were a way for us to discuss together since your presence in the saloon is... problematic, shall we say ? ;-)

  19. Yes I did read it and I've read previous reviews of that book but this is something I've known about for a long time especially the Berber Jewish queen Al-Kahina. It makes alot of sense that many Berbers adopted Judaism because they were exposed to the Punic/Phoenician languages (which were closely related to ancient Hebrew) spoken by the people of Carthage and its settlements scattered along the North African coast and southern Iberia. They would have been able to read the Torah if they were literate.

    The Khazars are pretty well known and the Hellenistic communities figure in the preaching of Peter and Paul.

    Two related and interesting articles touching on the roots of (hint:had nothing to do with the holocaust) and inherent contradictions within zionism.

    This article might interest you as a philosophical look at Euro-centrism from the subaltern point of view.

  20. Anyone have any other predictions?

    Hopefully "Globalisation" dies instantly and the demand for locally-produced goods and services provides plenty of real growth to keep people happy - even though most cannot pay the 10-15% interest on their mortgages and lose their homes & cars.

    But probably "Gloablisation" is defended tooth and nail by the people who profited from it in the past. In that case various nationalists and fascists will rise on the anger of people with no jobs and no money watching the bailed-out banksters dictating austerity measures...

    The EU will be over too!

  21. You are dealing with politicians who still think banks make most of their money from lending to people.

    Politicians thought that banks would spontaneously develop some sense of community, voluntarily modify mortgages and start making small business loans after taxpayers bailed them out.

  22. Hello Hell,

    I'm not poo-poo-ing your idea... but just rather thinking logistics.

    If the buyers of CDS have to have an invested interest, what happens when they sell? (these things fly around the market pretty fast. Does the CDS have to follow? If so, forced sells put the seller in a bad spot. Don’t they?)

    Likewise, much of this stuff is used as collateral. I've seen first hand collateral not returned and/or abandoned. You would still run into the same problem if you had buyers buying bonds and CDS, and then loaning out the bonds (for cash or equities) They'd still be just as inclined to burn down your house while standard lending practices exited. Wouldn't they?

    Love the feeback.
    All the best,
    Rich hartmann - Miss America

  23. Um... Yoyo, Mr Alam's thinking seriously smacks of... WESTERN entitlement.
    AND... he sounds rather like a whiner to me.
    We really ought to find a nice quiet out of the way place to discuss this kind of stuff...

  24. How about the previous comment thread, no one is using it.

  25. Browsing through Counterpunch this morning, I found this article for y'all.
    Nothing new, but the writing is good.

    See you on the last thread, yoyo...

  26. The dollar shall run!!!

    The Discount window just bumped 25 basis points!!!

    All the best.
    Rich Hartmann - Miss America

  27. Please give us a post on the meaning of today's rate hike. When will the prime rate follow?

    Value your comments!

  28. Throughout the world, scaling back the 20th century’s legacy of progressive taxation and untaxing real estate and finance has led to a public debt crisis. Property income hitherto paid to governments is now paid to the banks. And although Wall Street has extracted $13 trillion in bailouts just since October 2008, the thought of raising taxes on wealth to pay just $1 trillion over an entire decade for Social Security or health insurance is deemed a crisis that would lead Wall Street to shut down the economy. It is telling governments to shift to a regressive tax system to make up the fiscal shortfall by raising taxes on labor and cutting back public spending on the economy at large. This is what is plunging economies from California to Greece and the Baltics into fiscal and financial crisis. Wall Street’s solution – to balance the budget by cutting back the government’s social contract and deregulating finance all the more – will shrink the economy and make the budget deficits even more severe.

    Wall Street Moves in for the Kill

    Deb, my reply to your comment on prior thread didn't clear.

  29. @Yo re: "scaling back the 20th century’s legacy of progressive taxation and untaxing real estate and finance has led to a public debt crisis."

    This statement makes no sense! If it were true, then government spending could not possibly be at an all time non-wartime high as a percentage of GDP?

    If you are going to make one of those comparisons where you pretend all other variables are constant except two and then notice that the two variables you are examining have changed and therefore must be responsible for the effect you are noticing, at least you might have the honesty to point out whether a few other variables might possibly have changed along the way with the two you were examining.

    Get real Yo

  30. Hel,
    Did you know the Greece swaps story was already an issue back in 2003?

    "Get real Yo"

    Anything to please you Thai; any other requests? Specificity appreciated.

  31. Geez you guys are like roosters in a cage.
    Thai, I think Yo's link is pretty persuasive. It convinces me just fine.
    Playing Devil's Advocate has its drawbacks, you know.
    Yo, any OTHER ideas for a quiet, out of the way place ??
    Another expat tells me that you are all glued in front of women's figure skating..

  32. Wait...there are global regulators?

  33. "Yo, any OTHER ideas for a quiet, out of the way place ??"

    But I would miss the comforting presence of my precocious prodigy.

    Now before Hel activates moderation:

    "... in France at least, the kids learn their history WITHOUT taking into account the history of the Church"...and a lot of other important issues that shaped the world.

    I've read a couple of articles by John Taylor Gatto where he talks about efforts more than 100 years ago by industrialists to dumb down education to turn out compliant factory workers. The most distinguished psychologists were retained to design curricula to breed apathy and resignation in students.

    This is from an article in Harper's:

    We have, for example, the great H. L. Mencken, who wrote in The American Mercury for April 1924 that the aim of public education is not..."to fill the young of the species with knowledge and awaken their intelligence. ... Nothing could be further from the truth. The aim ... is simply to reduce as many individuals as possible to the same safe level, to breed and train a standardized citizenry, to put down dissent and originality. That is its aim in the United States... and that is its aim everywhere else."

  34. I read through both links attentively, Yoyo.
    It would take me hours to tear them apart, and Hell would not let us debate all the way through...
    Shall we say that I do NOT believe in conspiracy theories. I find them simplistic. Because the way things play out in the human psyche is even more breathtaking than simplistic conspiracy theories can handle.
    You should get your hands on Theodore Roszak's book, "Where the Wasteland Ends" . (He wrote "The Making of a Counterculture".)
    Gatto's points about the Prussian state and its organization are very important, as are his observations about the theories of social darwinism. Social darwinism has led to the excessive reaction present in our current society, but I direct you to my most recent post in the saloon "Synchrony vs Diachrony" for my perceptions of this question.
    Over here on my loony forum, I just addressed the question of... how our language itself (abstract words/idea, see Platonic and Neoplatonic thought) lead to the generalization that gives rise to social conformity. "Communicating" is dealing with abstraction. And.. abstractions are NOT flesh and blood people. They don't... SCREAM, or LAUGH, etc.
    Rousseau is much more breathtaking than Gatto, and more intelligent on questions that have been preoccupying us for some time. (Hint : Emile...)
    One irony, Yoyo... Notice how Gatto promotes the creation of his OWN elite, YOUR children that YOU educate to be... more COMPETITIVE ? BETTER than the masses ?
    Ah, the elite. OK when it's YOU, right ?
    When it's somebody else, it's TYRANNY.
    My dissident, very analytic teenage daughter, who is rather a social drop out at this time (like her mother...) is VERY BORED.
    Even though she is a thinking person...
    The problem resides in the fact that we are TRULY ignorant of the DEGREE to which we are social animals.
    That when the social body manages to close a meaningful door for us, it limits our individual freedom terribly.
    We are living in a very closed door society these days...
    But... the doors are opening. It's not comfortable, neither for the individual, nor the social body, but the doors ARE opening...

  35. "Notice how Gatto promotes the creation of his OWN elite, YOUR children that YOU educate to be... more COMPETITIVE ? BETTER than the masses ?"

    Anyone's children who are willing to invest the effort can inform themselves about superior teaching materials; it does cost money but it's not prohibitive, the biggest investment is time.

    As for coordinated efforts by interest-sharing groups to achieve sought after goals, we can agree to see things differently.

    I responded to your comment on population displacement on the prior thread #73

  36. LOL, Yoyo, you don't need a bundle to get educated, and you don't need state of the art tech, either.
    Think about it..
    WHY do you think our ancestors had a general culture that was probably broader than ours ?
    I read through Shelley's biography last night, and some of his poems.
    He got kicked out of Oxford, Yo...
    And he was BRILLIANT.
    He was self educated...
    Some of the most INTERESTING books are already in the public domain, and they will cost you next to nothing. And you can surf the Internet, and go to your local library for FREE.
    And you probably don't need to read ALL the books out there. You probably would get more out of REALLY READING WELL a few books, and connecting the dots, as you say. Because it is important to connect the dots... Very important. Difficult for specialists to do...
    I responded to your last comment on the previous thread that must have got through the filter after mine...

  37. I couldn't agree more. Once upon a time people expected to learn and think for themselves (connect the dots) but gradually have been encouraged to disregard anything not spoon fed to them by their BBB (benevolent big brother). Hopefully, with the convenient availability of the internet (for how much longer?), more people will accept the responsibility of being well informed.

  38. Back on topic even if there was a new message in between.

    In this interview, Yves and Chris seem to agree that prior to Delphi's bankruptcy in 2005, in case of a default, CDS buyers had to show the underlying assets to be paid. But they write that this rule was cancelled because in Delphi's case there were more CDS's than bonds outstanding which was surprise.

    It is the first time I read this story, and the Delphi bankruptcy is not that old? Does this make sense?

    Hellasious, do you have more informations about this? Indeed I think that it is not possible to improve rules for the future when history is not well known!

  39. I agree with you completely about history, Arnould.
    But... you have to be educated to have access to history.
    That's where Yo's and my discussion is on topic...

  40. Let's get back to basic, the three R's:
    1. Recapitalization
    2. Reintermediation
    3. Rebudgeting, on balance sheeet, on-budget
    If you need to buy credit risk cover, you shouldn´t be lending or buying bonds to begin with.
    Leave credit risk analysis and management to the professionals, with money at risk, not mere agents.
    Put everything on balance-sheet, now.