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On Banning CDS
A lot has been written and said in the past few weeks about CDS. Almost
all of it has been bad press for the poor boys who write and trade this
stuff for a living. Heads of State, leading academicians and
economists, the MSM and even some of the financial blogs have all been
pounding the table on this issue. The message has been pretty clear. “Something
has to get done, or we are really really going to blow up next time”.
The catalyst for the recent uproar has been Greece and to a lesser
extent the other PIIGS. The perception has been created that somehow the
existence of a CDS market for Greek Government Bonds has caused a
crisis. Nothing could be farther from the truth. We now know that CDS
had very little to do with the yield spike in GGB’s. It was the movement
by the low rent bond traders (AKA global investors) that caused this
hiccup. Greek CDS was the tail that got wagged. Not the other way
around. But the vitriol continued. Wolfgang Munchau wrote on this topic
last week. The following quote summed up his thinking:
“The case for banning CDS is about as
strong for banning bank robberies.”
Some of the arguments against CDS include:
(I) They are unregulated.
(II) They create the opportunity for excessive leverage.
(III) They are used for and encourage speculation.
(IV) They may be written by under capitalized firms. Depending on
the outcome this could create an excessive financial risk for the writer
and thereafter cause a systemic risk. (The AIG story)
(V) They can, by their very existence, precipitate or fuel a
financial crisis.
CDS is functionally an insurance policy one can buy to protect against
default of payments from a borrower. While it is different in a number
of respects from payment default insurance, it really is the same thing.
If you accept that CDS = MI then you have to look at what is happening
in that market. Mortgage CDS is the big casino; Greece and all the
others are just a sideshow by comparison.
First consider the private sector side of this. The mortgage insurance
industry (MI) is represented by an outfit called MICA. The current and
recent members of this group include:
S&P updated its views on the Mi providers in November 2009. Does
this sound like a group that is adequately capitalized? Their comments:
Overview
• The mortgage insurance industry continues to face significant
challenges
during 2009, to the extent that many mortgage insurers have reported
losses exceeding our expectations.
• We believe that the macroeconomic environment may be having an
increasingly negative impact on the prime mortgage insurance books,
suggesting an elongation of the loss cycle beyond our prior
expectations.
• As a result, we are placing the ratings for several mortgage
insurance
companies on CreditWatch with negative implications.
As of February 2010 this group had mortgage insurance in force totaling
$850 billion. Anyone who recognizes these names and understands
these ratings knows that this group is under capitalized. The number of
insolvencies of these firms and their failure to make timely payments
under their insurance obligations has already strained the mortgage
market. This group clearly represents a systemic risk to the system.
As insurance providers these companies are supposed to be regulated. But
they functionally are not. The fact that a number of them continue to
exist and write new policies (AIG) proves that there is no useful
regulation.
MI insurance allows a borrower to acquire a home with no or very little
skin in the game. We have learned that this is bad business and leads to
defaults. The D.C. mortgage agencies have learned this lesson the hard
way. They have been suffering defaults on their book of “enhanced” loans
at multiples of the rate of conventional mortgages.
In the heyday of mortgage silliness the MI companies were insuring up to
105% of the purchase price of a home or condo. This never should have
been allowed to happen. It clearly encouraged speculation and there is
no doubt that excessive leverage was the intended result.
In my opinion the MI industry has all of the negative
characteristics (I-V) that the detractors of CDS point to.
The private sector side of the MI business is a joke. But it is small
beer compared to what the D.C. lenders have been doing and continue to
do. As of the most recent reports, Washington has the following mortgage
CDS outstanding:
These numbers speak for themselves. That 50% of all mortgages
outstanding are guaranteed as to their performance by the central
government is the definition of a systemic problem. No one has any skin
in this house of cards.
The D.C. mortgage players are regulated, but by whom? The FHFA. The FHFA
and its predecessor OFHEO have never regulated the agencies properly.
The proof of that is staring us in the face. The absence of proper
oversight will cost the American taxpayers at least $500 billion dollars
before this mess is over. FHA will have its hand out for a federal
bailout by year end.
None of the mortgage agencies have adequate capital for this type of
underwriting risk. The joke is that they have no capital at all. The
equity necessary to absorb the losses comes from the taxpayer. We are
writing a check to cover that shortfall every quarter. That check
averages $10 billion dollars a month. And every month the agencies write
more CDS contracts. Nothing has changed.
The agencies have already proven that they constitute a systemic risk.
They helped create the mess in we are in today. They encouraged
speculation in the housing market. They have created the excessive
leverage that has caused the economy to shudder. If in the next few
years we find that the recovery does not hold and we slip into a
protracted period of recession it will be the mortgage agencies that
will be the albatross that brings us down.
The D.C. mortgage players clearly have all of the negative
characteristics (I-V) that those opposed to CDS are worried about.
It is all well and good for the press, our political leaders and many
deep thinkers to throw stones at the CDS market; no doubt some of these
stones are well intended and justified. But for me it is misdirected.
How can someone throw these stones while there is a $ 6.5 trillion CDS
market right here in the US and it is sanctioned and encouraged by
everyone one who has a say in the matter?
The reason is simple. Expedience and survival are at stake. If we woke
up on Monday and there were new rules that eliminated the MI and
federally sponsored guaranties on individual mortgages we would be in a
depression by the end of May. Our system would simply freeze up and die
if that would happen.
To a much lesser extent the same is true in the global debit insurance
business or CDS market. If that were taken out of the equation it would
have significant global deflationary impacts. Those that are taking up
the mantle against CDS should address their concerns to where the truly
big numbers lie. They also need to understand that the direction they
are headed will lead us to that horrible sucking noise of deflation that
everyone seems so desperate to avoid.
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they should be exchange traded with collateral required. Note also that, with the discussions of fire insurance and life insurance, the companies writing the insurance are required to hold reserves.
Enough said, end of story.
Don't ban naked options or puts or short selling, just charge proper margin.
"The absence of proper oversight will cost the American taxpayers at least $500 billion dollars before this mess is over. FHA will have its hand out for a federal bailout by year end."
Very nice work Bruce and well thought out. I think the $500 billion number is a bit low but we'll see how it plays out.I think a trillion is far more reasonable. There is no doubt the FHA we be in line for a bailout by year end. With the FDIC in freefall, FRE and FNMA (the sick and the dead) by year end, we as taxpayers will find 2008 looked like a best case scenario. That's what happens when the zombies are rescued with minimal life support.
What irks me is that those with less than millions cannot participate in the CDS market unless they are in a large hedge fund. So we are stuck with traditional options on currencies or companies or broader indices. But that's ok...I don't want to speculate on that anyway. I have my choices of where this market is going on the downside.
This is one the best pieces you have written in some time, IMHO. Thank you for staying with us, Bruce. We need you. Thank you.
Thank you KARL!! Thank you for your insane ability to break down the issues for the Idol-watching masses--
We love you, Mannnnnnnnnnnnn
NOW FASB Wants To Do The Right Thing?
This is unbelievable:
The war over mark-to-market accounting is about to get hot, again. In coming weeks, the Financial Accounting Standards Board is likely to propose that banks expand their use of market values for financial assets such as loans, according to people familiar with the matter. That departs from current practices in which banks hold loans at their original cost and create a reserve based on their own view of potential losses.
Let's cut the pump-monkey crap and recall for everyone exactly how that "current practice" came to be, shall we?
Back last spring as I have written about more than once, the dishonorable Mr. Kanjorsky, Barney Frank's stooge, held a hearing in which he basically put a gun to FASB's head and informed them that they would allow banks to mark their loans to model - or Congress would introduce a law overriding FASB.
FASB objected, but it didn't matter. In the end they relented.
This was the catalyst for the huge rally in the stock market. It was a declaration of legalized accounting fraud from the people who oversee financial accounting matters.
Now, a year later, after Barney Frank comes to realize that it was precisely this "gun up your butt" approach to financial regulation that has made all efforts to modify home loans (including cramdowns) worthless, we see some effort to change things.
Why does it make modifications worthless? Simple - a second loan behind an underwater first (e.g. a HELOC) is worth zero if the first is underwater and forecloses. That's because it is a subordinate lien and is only entitled to be paid (at all) if the first is fully recovered. In a case where the first is underwater, it won't be recovered; ergo, the second is worth exactly nothing.
But "mark to fantasy", otherwise known (by me anyway) as legalized accounting fraud, has these banks carrying the loan on their books at or near 100 cents on the dollar. That's because "the loss hasn't happened yet", so since they're entitled to "model" a potential outcome 30 years in the future, they can say "well property prices won't stay down for that long, so we don't have to take the loss!"
It's bogus of course as the odds of someone paying on an underwater loan for a decade are close to zero. Anything that interrupts the borrower's cash flow - a loss of job, a medical problem, or simply being tired of taking it in the cornhole month after month while they could buy a house across town for half the price - results in a foreclosure, because the property isn't worth enough to sell and extinguish the mortgage.
Under mark-to-market rules banks had to price these loans at the current market's appraisal of their worth. Thus, as home prices declined and people were more and more underwater the market price would fall toward the zero that would be recovered if the foreclosure happened. This would in turn make the foreclosure no more damaging to the bank balance sheet than not foreclosing, and thus, the market would tend to clear.
But no! We can't have that! So instead we have this fantasy. The consequence is banks letting people live in a house that they haven't made a payment on in a year - and sometimes two. Nobody cares if the loan is performing or not, because it was probably sold to some poor bastard and the servicer is advancing interest payments anyway! Moody's, S&P and Fitch keep downgrading these bonds in a furious fusillade, but nobody cares at the bank, because the bank doesn't hold that paper - some fool pension fund does.
(What's left unsaid there, of course, is that said pension fund might be getting their interest payments now, but they sure as hell will not get the principal at maturity - because it doesn't exist. What that will do to the pension funds is obvious, but heh, so long as the banks get to lie, it's all ok that pensioners get screwed, right?)
What the bank holds is the HELOC and they are often the servicer as well. They have a terrible conflict of interest in this regard because if they foreclose then the HELOC is worth nothing, and they take the full dollar hit right here and now. If that was to be done across the board with these delinquent loans my analysis shows that many banks Tier 1 common equity levels would be forced below regulatory minimums and in some cases would be destroyed altogether. The latter would force immediate FDIC seizure. It is thus cheaper to advance the interest payment to the bondholder and pretend, even though the payments aren't coming in, praying that somehow the borrower who hasn't made a payment in a year will suddenly come up with $25,000 to "come current." (Yeah, right.)
Let me be absolutely crystal-clear - this is an outright scam promulgated by the same jackassery in The Government (SEC, Treasury and Congress) and The Fed that led to the destruction of Lehman. Instead of forcing these institutions to take their marks and admit to their losses they were allowed to put forward abjectly false and misleading financial statements. In the case of Lehman it appears the law was broken. But in the case of the big banks today Congress got the rules changed by shoving a gun up FASB's nose so as to make the INTENTIONAL false reporting of asset values a lawful act.
This should have absolutely never, ever happened and those dishonorable knaves in Congress responsible should resign NOW.
These banks should have been taken into receivership by the FDIC and closed. We would still have the $3 trillion we have blown trying to prop up the economy - well more than enough to pay off the depositors when the assets were liquidated. Deposits would have been dispersed to strong community banks, lending them further strength and ability to lend to qualified borrowers. The scam-meisters on Wall Street would have lost their jobs and been closed down, we would have taken a horrific hit in the market but it would now be over and the economy would truly be on the mend.
Instead we lied and pretended, creating a false dawn and a market rally based on nothing more than a scam. This cannot hold indefinitely, and yet the conditions for a true recovery in those asset prices will not happen for over a decade - if ever. If we do not stop this insanity cash flow will force the issue eventually and by then The Government will have blown its wad furiously trying to replace 10% of GDP in the private market, as it has for the last two years, and thus be unable to fund the FDIC deficiency.
The simple fact of the matter is that as I have written about for over three years I absolutely believe that if valued on market prices these banks were insolvent then and are today. Hiding the fact of that insolvency with bogus accounting fictions does nothing to solve the problems that face us and in chokes off lending, prevents markets (especially housing and commercial real estate) from clearing and will absolutely prevent any durable economic recovery from occurring.
Oh yes, it has pumped the stock market to the moon, but the test is not whether the stock market goes to the moon - it is whether the market price reasonably reflects underlying fundamental value, and there the evidence is clear - it does not.
The danger here from continued obfuscation could not be more grave. We may have already passed the point where the government is capable of funding the deficiency to come in the FDIC accounts, but if we do not stop this crap, it is a certainty that such will occur, exactly as did in Iceland.
Be nice if you would put a name to that fine rant-a-logue. It's rather hard to follow anon's ideas as there are so many of them. And, very few make such sense.
Consider it.
the piece was written by karl denninger at market-ticker.org
I think the world made out fine without CDS's in the past and can do so in the future. Individually, the are fine if utilized for the right reasons, but it is the old 80/20 rule. 20% are not using them for the right reasons or are not worthy counterparties in times of illiquidity. I understand they were originally called swaps and not insurance in order to avoid regulation, but I think everyone should just grow up and allow transparecy and oversight.
It's like the cell phone. We lived for years without and now we would die without it. You can't reverse history.
GSE reform was put off for one reason and one reason only, to sweep the problems at the GSE's under the rug until healthcare is passed. Dont think the American public would to to keen on supporting another 1 trillion entitlement if they knew the extent of the losses and FN/FH or FHA. When FHA insurance fund turns negative late this year or early next year we will see if the Administration comes clean.
Nice analysis (as always) Bruce. Your a reliable voice of reason in the propaganda storm (from both sides) we live in. I'd suggest that at the point that CDS cease to be treated by the broader market as insurance against real counterparty risk and turn into a means of speculation on that risk, the game's probably over. I suspect this will all go on for much longer than many here think possible, but it when the game finally ends (when then last bears surrender in exhaustion), it will fail in catastrophic ways that most of us can't even imagine. The longer the bubble inflates, the bigger the explosion when it finally pops.
Bruce
If you hold a preferred stock of a public company and you "get nervous", the reason you are nervous is because of material public information. Thus the price of the stock will drop and the price of any other protection you seek will rise. There simply cannot be a solution for every nervous investor. Suck it up and hold on nervously, or find a buyer for that issue and sell it to him/her/it. The problem with the Street and all the "swaps" is that it is illegitimate reasoning that creating more complex balances for everyone who owns a position to sort of get out of it is good for the system. It is only good for the middlemen who get a cut of every transaction.
The middleman gets a fee when the position is liquidated. The difference is?
The Put costs a fee but allows the security owner to still gain from expected improving prices for the shares. It is not the same position at all as being out of the stock. The investor can make their own judgement about the costs and benefits of the different holdings and risks. Your proposed solution of liquidating quite restricts the available choices with no demonstrated benefit. For some reason you appear to believe that the butcher who cuts up the side of beef should not be able to sell the parts for more than the whole.
If anything, we should trade swaps against even more types of credit.
Micro-lending, for example.
Loan some poor, fledgling dairy farmer $100 to buy his first cow, then collect profits on the hedge when the cow dies.
Derivitives are obviously a problem and the evolution of them. They have continually caused problems because there is no regulation. If there was regulation then it probably wouldn't be enforced anyway . The same as any regulations or agencies we have in the other sectors of government.
The more complex the system the easier it is to obfuscate.
You should be reminded that ALL commodity futures are derivatives. Further, all of the Puts and Calls traded on the Options exchange are those evil derivatives.
I believe that there would be pretty quick agreement that they should be exchange traded with collateral required. Note also that, with the discussions of fire insurance and life insurance, the companies writing the insurance are required to hold reserves and there have been very few failures.
I'm referring to swaps.
Mortgage insurers are worth more alive than dead. To someone, probably the GSEs.
Does anyonehere know by how much mortgage insurance policies owned boost the value of GSE mortgages held? Maybe I'm a cynic, but I bet it is over ten times the market cap of the MICA mortgage insurers combined.
And this is no worse than the accounting methods used by our banks. So the MI issue is part of the culture of dishonest acounting which permeates our financial system.
CDS is a whole different issue because unlike MI it is neither standardized, transparent, or regulated. It is not insurance, at least no insurance which can be sold legally.
IMHO CDS is a legal but unenforceable gambling contract.
The author seems to talk like a banker: that is to make the issue complicated and insoluble except by the bankers, who by the way are also the coauthor of the legislations to which they are deregulated. The author then comes around and blame the government for the lack of regulation.
The fact is that between the years after the banking act of 1933 and and the Gramm–Leach–Bliley Act of 1999, the US was fine without these derivatives of mass destruction and the US will be fine if these instruments are retired eventually.
Deflation? Is that what you're worried about?
Over 300 years are the Brits understood the dangers of insuring assets in which the insurance buyer has no economic interest.
Hey Bruce, would you be worried if one after another various people with shady past started insuring YOUR life? Would you feel more or less secure? Would deflation would still be your biggest worry?
I am not even talking about selling insurance "the AIG style" - without any ability or intent to pay if s**t hits the fan! If i make similar promises - i will be prosecuted. They, on the other hand, know that they will be bailed out.
The vicious circle of naked derivatives has to be broken, the sooner the better. We'll either have deflation now, or much larger one in a few years and after numerous defaults and panics in other countries. Either we will restrict/regulate derivatives or they will do us in.
Well I would agree with you on one point. The big risk in front of is deflation. The pieces are there for this to happen. So why do something that would tip the scale in that direction?
Maybe what we need is the big D. I don't know. It would hurt a lot but it woud address some of the silly things that are going on today.
If we do slip back into a recession (or worse) it will take many years to crawl back out. There will be no TARP or QE to fix this. But when it is over there will still be guys trading CDS on the curb.
Bruce,
It's not the instruments but the idiots wo use them in speculative or destructive ways. I've seen pensions selling CDS (and geting creamed) as well as hedge funds using them to profit of Nortel's bankruptcy, leaving many pensioners there scrambling to strike a deal for their retirement security.
Leo, What wrong with that? I was short Nortel stock and did okay. You want to stop me from doing that? I hope not. Sometimes I lose and that is the game of risk. If you take away the game I can't play. But you need me to take some of these risks. I am providing the equity that makes thing thing work.
Do you play poker? When you sit at a table you want a few of the others to be bad gamblers. It cuts your odds. There is aways dumb money around. So what? When they lose they add to the pool that supports the risks.
Sorry for my late response, but what is wrong with that is that you had hedge funds naked shorting Nortel to make money on their CDS. It's not all benign risk hedging activity as you make it out to be.
Leo,
You could get every hedge fund in the universe to short the stock bonds and CDS of Cisco Systems (or a bunch of other names). It would come to nothing. Wouldn't hurt the company or the investors. It would kill the guys who tried it however.
The reason is that Sys is solid. LEH, Citi etal are/were not. The were vulnerable to an attack because they were weak. Look at the LEH story. These guys were dead months before the went tabioca. CDS may have stepped this up by a week or two. The outcome would have been the same either way.
Coyotes hunt in packs and prey on old sick animals. So we think they are terrible and try to kill them. But really they are just culling the weak. They are doing the herd a favor. There is not enough food for all the animals to live on. Some must die from time to time.
You and the others are making CDS to be like the coyote and you want to kill it. Watch out, you will regret what you have done.
You're a professional investor, all good. But the way that CDS and other instruments were made, marketed and sold (not least in connection with mortgages) put a lot people at the poker table who did not know they were playing poker, who did not know the rules of poker, and who had no surplus capital to bet. That's what 'systemic risk' refers to.
That's a problem: gambling is fine for gamblers, but the structure of US financial markets made a lot of us, not least taxpayers, unwitting suckers in a game that you knew the rules to, but we didn't.
It's one thing to be a bad gambler at the table you chose to join. It's rather different to wake up in the middle of the night in your pajamas and find out that a series of players you never heard of have taken your savings because they need a 'bad gambler' to grow their stacks of chips.
Fantastic piece Bruce. I always learn more every single time that I read one of your pieces. Thank you!
Bruce is a treasure. One very smart man that we all can learn from....thanks again Bruce for continuing to support ZH with your wisdom, insight, and contributions.
Well understood here Bruce...but there is the usual caveat here. I completely understand that the CDS table pounding by Greece and other politicians is complete BS. There are numbers proving very well that Greece cost of funding has grown EXCLUSIVELY due to the dumping of their CASH paper as the worthless trash THEY have rendered it. So Far so good.
But the CDS great danger is, IMHO, the fact that they allow you to take protection on something WITHOUT any interest in the uderlying.
If you are holding XYZ debt, and u suspect they may default, a CDS is perfectly legitimate, as it means you wil buy protection but keep the paper on your books, i.e. do the synthetic equivalence of just selling that paper once in the market...and stay put.
But if you buy the CDS and then DUMP that paper on that market, you sold twice...i.e. you LEVERAGED your bet against that paper/entity, effectively doubling the effect and accelerating that paer drop in value.
But the main point Wall Streeters Do NOT want to discuss, is that in no sane system you would be allowed to take out an insurance on MY house...because if you do so, and I am a well known smoker with Alzheimer, and all the neighbours take out that fire insurance on my home...If and when it will go up on fire, the insurer will be facing the replacement cost of n times my own, and if he sold , say, 25 insurances, he will all of a sudden face the replacement cost of a sizable hurricane...with just the loss of my home to fire.
In that sense is necessary to link a CDS to holding the underlying or an interest in the underlying, to reconduce the betting game in the field of insurances and out of the casino.
Would you like to elaborate on this simple but vital point ?
I get your point. But take this a bit futher in this complicated world.
Assume I preferred stock in some company. I am nervous so what can I do?
I could just dump the pref.
I could sell some common or buy some puts.
I or could buy some cds protection. My pref is close to the sub debt that the CDS is priced against.
Which of these options would you take from me? Just the CDS? That is not a reasonalble position to take.
Leveraged ETFs cause volitilty in the equity markets. So what? It doesn't really matter after an hour or so. None of these tools move markets. Fundamentals move markets. Not deriviatives
"Fundamentals move markets. Not deriviatives"
Of course this is the case over the longer time span, shorter duration, everything can move the market, especially a speculation that AIG (example) is faced with paying insurance of 100's of billions which they do not have! Will fundamentals help here?
Derivatives need to be regulated and limited to the paying ability of the issuer (seller). You can't have a shitty institution underwrite $trillions of risk assets for which there's no hope that they can pay if needed.
This whole article is written only to take a contrarian view. Wrong place to take the contrarian view. Mainstream is right too sometimes.
I do agree with you that an outright regulation/deleveraging of the existing contrasts would spin us right into the 30's kind of gepression. We do however need to start rationally deconstruct some insane contracts and not allow new contracts to be taken on by any institution beyond their ability to meet their obligations.
I would take nothing from you, allowing you the full range of options, including the CDS...AS LONG AS YOU HOLD THE PREFERRED STOCK. The moment you sell the preferred, I would rather have you unwind the CDS and, if you run money, go short the ordinaries after the regular stock lending process. I am not even insisting on an uptick rule...is useless...and people thundering again naked shorts do not know how the DTCC settlement takes part.
But it would be useless to remind you that AIG just did that...sold insurances and merrily cashed in millions of dollars of premiums , insuring John Paulson and others against risks...they were NOT holding.
In principle, is not wrong, is a private contract, BUT YOU ARE CIRCUMVENTING ANY RULE OF INSURANCE.
To all effect, AIG had sold insurance on MANY TIMES THEIR CAPACITY TO REPAY, SPREADING THE BET ON A RESTRICTED HORIZON OF EVENTS I.E. A RESRICTED POOL OF MORTGAGES WITH HIGH PROBABILITY TO DEFAULT....BUT SELLING PREMIUMS FOR SEVERAL TIMES THE REPLACEMENT/PROTECTION COST OF THOSE MORTGAGES.
It is unrestricting irrational, illogic behaviour, that you originate systemic risk.
CDS unrestricted, unchecked and unregulated , ARE Weapons of Mass Financial Destruction....short selling, and options are, on the contrary, risk mitigation instruments.
But NOT CDS Bruce, Sorry...I'm very specific about that.
And BTW, also leverage should be limited...if the Banks/Broker dealers had been restricted in their leveraging equity to assets to 12.5 times as per existing rules, and not being permitted by a specific SEC exemption to go to 30/35 ratios of assets to equity...we would not be here talking about systemic risks.
Unfettered, unrestricted, unregulated capitalism is NOT always good Bruce..It is right to separate a fool from his money, possibly from ALL his money...there is something wrog to separate a fool from SEVERAL TIMES his money. Means other fools ( taxpayers..) have to put up the difference to "keep the settlememnt system from collapsing". That is wrong...
Prevent it, is better.
What you are overlooking is that CDS has nothing to do with whether Greece makes the payments on the bonds. IF Greece makes the payments, there is no default and no insurance payment.
So Greece issued 10 yr bonds with 5% coupons at 100. If I sell mine at a later date at 88, what did it cost Greece? If I did take a loss on my bond, why would that cause Greece to default?
These governments and their populations are simply being called upon to honor the promises they made. It is becomming more obvious that it will be impossible to honor all of them. Which party do you believe they will leave holding the bag, the pensioner populations and govt. employees who vote, or the evil rich who own those bonds? What they fail to recognize in making the choice is that the pensioner populations own the debt and the economy through their investments. Never mind that as any failure of that type can be blamed upon some wealthy investment manager who should have known better.
Oh, if it plays out anything like in the US, bondholders take the hit. Unless, of course, you're a bondholder in a financial institution.
most excellent insight... bravo..who are you :)
I agree with the content and the sentiment. I think you have gone as far as you need to on a fit cut basis. I also think that you could (if you needed to) go even further and correlate the "nationalisation" of the housing market via the FHA/Treasury (fraudie and funny no longer exist, you have to go to who signs their checks) with the use of insured collateral pools that are lodged as collateral at the Fed. This is a shell game that is also in play.
Never mind that MI companies are already insuring an insured asset (mortgages should already insured by the due diligence of the lender of the mortgage) so this is doubling the insurance/due diligence aspect and costs of writing mortgages; the double jeapordy reflects a violation of the original mandate of the housing agencies.
The original purpose was to provide government funding for housing the poor. These agencies instead bought and continue to buy mortgage pools from banks (handing the banks an instant profit of the spread between the mortgage rate and the pooled pool rate of around 1% times the duration of the pool of 7 years) and then cost the tax payer a further 0.5% times the 7 year credit spread duration between fraudie and funny debt.
Your CDS volumes (which represent a further doubling down of costs as per the previous paragraph) make this annual cost equivalent to 7 trillion in fraudie and funny mortgages outstanding times 1.5% per annum. You can PV this at the spread duration ( to come up with around $735 billion) but again you could argue that this is false logic, since the loans are never repaid and the housing stock is constantly being refinanced. This 1.5% is an annual cost and impoverishes the tax payer who I am sure would rather the money was spent on schools, kids, security, health and pensions.
Take the first order 0f 7 trillion times 1.5% and then factor in the PV of this at an intervened Fed Funds Rate being used to juice the system currently and use a cap factor of 1%for next year and 2% for next year (priced into FF futures today) and the drain on the capital stock that the FHA/Treasury is imposing is truly horrendous.
The last shell (this shell game has a grenade under each shell that you detonate as you lift the shell) is that the other fraudie and funny banks are playing the same game with collateral and repos. Check out 105 and tell me that this isnt a standard ploy that is window dressed in other non-105 ways that are equally pernicious. The same fraudie and funny securities are being used as collateral and for repos. You take the size of the P/L in the market today and its not an issue. A reversion of the Fed Funds rate to a "normal" one of 3-4% means that even with the leverage reduction and netting off of swaps (including CDS) we have seen so far, the P/L impact and the sucking off of repos to be turned into collateral becomes horrendous.
But then again, you have correctly highlighted a key systemic risk. What remains is for some bright spark to say that the cost of the bail outs, exceeds the cost of the entire US housing stock over the last 50 years and maybe finally someone will twig what the financing system (including mrotgage insurance) is actually doing to all of us.
Who will win a pulitzer first?
A) "TD"
B) Bruce
C) Reggie
D) All of the above
Fantastic picture Bruce. You made my day. btw..mainstream media (yahoo finance) posted article on the SSTF's travails and how they need to start getting money back from Geithner. Whats he gonna do now ????
Hopefully resign.