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Debunking Some Myths About The "Greek CDS Contagion" Threat

Tyler Durden's picture


Now that the Greek bailout is topic front and center for the second year
in a row, it means that it is time for the mainstream media to once
again prove to the world that in the past year it has learned precisely didley squat about
how the more complicated securities used in capital markets operate.
Such as CDS. Just like in May 2010, the prevalent trope among the clickbaiters
is that CDS written against Greece will destroy the world, in
superficial attempts to bring about panic induced by the faulty
conventional wisdom that CDS was the cause for the implosion of AIG.
Well, wrong.

First, for those who actually care, CDS is nothing more than a low margin synthetic method to express a bearish position on an underlying credit (such as US government bonds), in the process facilitating market clearance and price discovery. Period. And as long as there is an idiot who is willing to take the other side of a trade which expresses nothing more than appreciation of risk, CDS can be written into existence (which is how Paulson made his Abacus money) or traded on the secondary market (the fact that said idiot is still trading CDS is thanks to the US government policy of making financial risk and failure a thing of the past, but that is the topic for another post). Another key CDS feature that is constantly ignored by nearly everyone is variation margin, or the daily posting of cash collateral based on intraday moves of CDS. This was extensively discussed in our post on the threats posed by the $600 trillion OTC market. A third key fact is that all the data on Greek CDS is publicly available yet nobody bothers to actually check it: after all why let facts stand in the way of a good story. So here are the facts: there is $5 billion in net notional daily margined risk exposure on the Hellenic Republic (also known as Greece). This is a 28% reduction in net notional risk over the past year, the largest drop in risk exposure of any of the top 30 credits tracked by DTCC. The total notional of Greek CDS outstanding is the 21st biggest in the world, behind such names as Italy (at the top), France, Spain, Goldman, JPMorgan, Berkshire and Wells Fargo. Lastly, 5 Year Greek CDS (at last check about 45 points upfront) is currently trading wide of cash bonds, which upon an event of default will likely rise on short covering and higher recovery expectations, which means that sellers of protection will actually receive a cash payment from this point until an actual EOD occurs when the basis between cash and CDS collapses.

The truth is that there is certainly risk from a Greek contagion effect, and far more than a risk -  it is a certainty, and the catalyst will be none other than the world's largest and most undercapitalized hedge fund - the ECB, which holds tens of billions of Greek debt as cash collateral which would have to remarked 50% lower in the process making the key European liquidity backstopper insolvent (in practice if not in theory: after all the ECB will just print more €), forcing a self-fulfilling liquidity run prophecy. But the contagion risk is not in Greek CDS, where risk sellers have not only contracted their exposure by the largest amount of the most active contracts, but where daily steady cash outflows to satisfy variation margin mean that banks have "overreserved" for an event of default, and may in fact be cash inflow beneficiaries.

As the DTCC-sourced chart below shows Greek CDS has seen the largest drop in net notional outstanding among the 30 largest positions. Furthermore, as can be seen it is well down on the table. The names in the top 5 positions should be a far greater source of risk, as that is where the perception of risk, and the market "reality" have not yet converged.

Most important, at least in our opinion, in the table above is not the 21st ranked name, but the 26th one, which has seen the change in its net notional CDS outstanding increase by 136%, or the most of the top 30, over the past year.

It should be rather obvious which "entity" is ranked #26... soon to be #1.

And for those who missed it, such as the entire mainstream media, here is your guide to the uber secret intricacies (yet completely public to those who search) that actually happen in CDS daily margin flows.

CCPs typically rely on four different controls to manage their
counterparty risk: participation constraints, initial margins, variation
margins and non-margin collateral.

A first set of measures are participation constraints, which aim to prevent CCPs from dealing with counterparties that have unacceptably high probabilities of default.

The second line of defense is initial margins in
the form of cash or highly liquid securities collected from
counterparties. These are designed to cover most possible losses in case
of default of a counterparty. More specifically, initial margins are
meant to cover possible losses between the time of default of a
counterparty,8 at which point the CCP would inherit its positions, and
the closeout of these positions through selling or hedging. On this
basis, our hypothetical CCP sets initial margins to cover 99.5% of
expected possible losses that could arise over a five-day period. CCPs
usually accept cash or high-quality liquid securities, such as
government bonds, as initial margin collateral.

As the market values of counterparties’ portfolios fluctuate, CCPs collect variation margins,
the third set of controls. Counterparties whose  portfolios have lost
market value must pay variation margins equal to the size of the loss
since the previous valuation. The CCP typically passes on the variation
margins it collects to the participants whose portfolios gained in
value. Thus, the exchange of variation margins compensates participants
for realised profits/losses associated with past price movements while
initial margins protect the CCP against potential future exposures.
Variation margins, typically paid in cash, are usually collected on a
daily basis, although more than one intraday payment may be requested if
prices are unusually volatile.

Full link for the above.


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Sat, 06/18/2011 - 19:04 | 1381267 scatterbrains
scatterbrains's picture

wow fukin scary. I wonder where the U.S. ranks on a "greatest year over year increase" ranking ?

Sat, 06/18/2011 - 21:47 | 1381404 Pure Evil
Pure Evil's picture

Beyond fekin' scary.

And, we're supposed to believe that ordinary humans are more than capable of managing a system this complex. And of course all tangibles and random events have been taken into account, much less, someone hacking into the system and causing chaos.

No black swan events here. The smartest men in the room, no scratch that, Top Men, are large and in charge.

You know, everything is hunky dory inside the hydrogen bomb, right up to the point where fission occurs. After that its just a cascading event that can't be stopped, well, not by mere humans anyway, until the nuclear fuel is spent.

Sun, 06/19/2011 - 10:58 | 1382381 Transformer
Transformer's picture

First word of explanation and I am lost.  What is a CCP?

Mon, 06/20/2011 - 16:02 | 1386123 AbandonShip
AbandonShip's picture

CCP = Central Clearing Party

Like the Intercontinental Exchange (ICE) in the U.S. or London Clearing House.  Basically these CCPs bring together the various CDS dealers (banks) and their clients (hedge funds) to try and "clear" the trades so that we can reduce the systemic risk (the CCP would have all the risk theoretically, I know I'm really watering this down so don't bother objecting.)  Think of going from a messy spiders-web design to a hub-and-spoke model like in a bicycle wheel. The second design is "better" because all the "counterparty" risk goes to the middle (the CCP).

Sat, 06/18/2011 - 19:15 | 1381276 ZeroPower
ZeroPower's picture

Nice, finally an up-to-date net notional number for GRE CDS.

Tyler, an MD informed me apparently no single CDS has to be reported to the DTCC - hence the wanting of an exchange by stakeholders to finally bring in true verified numbers. Any idea if the DTCC only sources and requires US banks to provide this information? Cant imagine all desks worldwide would want to or care enough to report to the DTCC.

Sat, 06/18/2011 - 19:17 | 1381281 Tyler Durden
Tyler Durden's picture

Wrong. Since 2009 every CDS transaction has to be reported to the DTCC. Does this mean the publicly reported data is ironclad? Or that has to be means is? Of course not.

Sun, 06/19/2011 - 00:05 | 1381833 unununium
unununium's picture

One naturally wonders how much exposure remains from contracts written pre-2009.

Sun, 06/19/2011 - 10:10 | 1382322 Tyler Durden
Tyler Durden's picture

Very little due to 3 years of rolling

Sun, 06/19/2011 - 11:20 | 1382428 oogs66
oogs66's picture

yes, the rolling has played a big role, and even the implementation of SNAC had a big part as many existing trades were converted to SNAC trades at the time to ensure liquidity

Sat, 06/18/2011 - 19:37 | 1381307 Arius
Arius's picture

interesting stuff...

Sat, 06/18/2011 - 19:49 | 1381324 gwar5
gwar5's picture

So, if/when Greek defaults or restructures, Greek bonds held by the ECB and all the other central banks will be slashed, shrinking their books, creating a liquidity crisis because they will all have to scramble for cash to replace the bond losses to maintain reserve requirements. I think I got it.

No doubt the other PIIG bonds will be selling at a discount at that point too, making things worse. Dominos.

Well it's certainly good to know that amidst a massive liquidity crisis big enough to threaten the global monetary system, the puny derivative market is safe and sound and fears of a secondary chain reaction are unjustified.


Sat, 06/18/2011 - 22:00 | 1381607 Fascist Dictator
Fascist Dictator's picture

"the puny derivative market is safe and sound and fears of a secondary chain reaction are unjustified."


thanks for the laugh. a quadrillion or two ain't what it used to be.

Sat, 06/18/2011 - 20:16 | 1381327 Daneric
Daneric's picture

It is of my opinion the banksters are fighting the Greeks so hard about haircuts is because they cannot afford to set a precedent for others to follow.  If the Greeks get off the hook and default on part of the debt, it is clear to me every other country that has debt problems will obviously be looking for the same - defaulting or forcing haircuts on chunks of debt. 

Greece may not blow up the system in and of itself, however if every other nation follows Greece's lead - and why wouldn't they? - well, yeah you got a problem.

EDIT: And to add that is probably why they are trying so hard to figure out how to go about a restructuring without triggering a credit event - not because Greece will blow it up - but because precedent will be set and any other nations that follow that have a higher ranking on this chart WILL blow it up. 

So it all comes down to precedent which is why they are squirming so hard to come up with a scheme that will NOT set precedent necessarily. It also comes down to: If we let them off the hook - or even to be PERCEIVED to be letting them off the hook, we open the Pandora's box to some of these other countries that have even bigger debt problems and it snowballs.

This is all a very pyschological game being played here for world audiences by the banksters.  In the end, it'll fail, because escalating riots will do that. 

Sat, 06/18/2011 - 23:30 | 1381768 treasurefish
treasurefish's picture

Precedent = Sovereign Iceland

Sun, 06/19/2011 - 04:42 | 1382066 richard in norway
richard in norway's picture


Sun, 06/19/2011 - 08:30 | 1382214 bonderøven-farm ass
bonderøven-farm ass's picture

A drab of state, a cloth-o'-silver slut,

     To have her train bourne up, and her soul trail in the dirt

Sun, 06/19/2011 - 09:25 | 1382272 Daneric
Daneric's picture

Yes they like to keep that out of the news. 

Sun, 06/19/2011 - 09:38 | 1382280 dcb
dcb's picture

I believe this view 100%. in fact if one thinks about future access to capitial markets, in a word flush with capitial, I'll buy the new debt of any country that repudiates the old debt. I have troied to get my handds on icelandic bonds without success (any help here). hedge funds, the brics, etc will all step intot he market. I make aceptions for banana republics like ecuador. the power  that be make it worse by extending loans, instead the total amount lost increases almost certain to become a systemic event. then we can just bail the banks out more. it is so disgusting, that I can't figure out why people are taking pot shots at these people. I am astounded at how corrupt the system is and thet at least in the us we aren't rioting saying these people need to go.


I think there is only one outcome in the end, and that is civl war. In fact I think the administration knows this and has been laying the ground work with increased domestic spy apparatus, etc. if you can't see the set up for the crisis, where we force the populace to be hostage to the bankers you are in fact blind.

Sun, 06/19/2011 - 16:05 | 1382925 sgt_doom
sgt_doom's picture

"It is of my opinion the banksters are fighting the Greeks so hard about haircuts is because they cannot afford to set a precedent for others to follow."

Naaah.....they just want to PRIVATIZE EVERYTHING.

First they establish all those "public-private partnerships"....

Phase II:  Next, they privatize everything.

Sat, 06/18/2011 - 19:56 | 1381329 Lord Welligton
Lord Welligton's picture

"And as long as there is an idiot who is willing to take the other side of a trade which expresses nothing more than appreciation of risk, CDS can be written into existence"

Maybe I don't get it.

But idiots are not allowed.

Participation constraints?

Sat, 06/18/2011 - 19:58 | 1381331 Lord Welligton
Lord Welligton's picture

"First, for those who actually care, CDS is nothing more than a low margin synthetic method to express a bearish position on an underlying credit (such as US government bonds), in the process facilitating market clearance and price discovery."

Where is the price discovery on banks, including the ECB, that hold Greek debt?

Sat, 06/18/2011 - 20:07 | 1381348 jm
jm's picture

The point is that CDS allow an investor to hedge his exposure.  Without it you have very inadequate hedge instruments, so investors will sell and credit markets lock up.  Financing for all enterprises and govts will be reduced by a lot, as spreads will rocket.

Sat, 06/18/2011 - 20:21 | 1381378 Reese Bobby
Reese Bobby's picture

Uh, uh.  So an investor who owns Greek bonds can buy protection on a like notional amount to hedge exposure.  And there is a new party that sold the protection long the original notional amount.  What does that accomplish besides levering up the original mess?

Sat, 06/18/2011 - 21:30 | 1381533 XPolemic
XPolemic's picture

The theory is that it is better for a billion people to lose* 1$ than it is for 1 person to lose a billion dollars.

The problem with that theory is that a billion people disagree with it.


* Okay okay: risk a dollar.


Sun, 06/19/2011 - 08:17 | 1382210 jm
jm's picture

That's not the point at all.

IF spread jump and stay there, then a lot of business wil go under becasue they can't roll their debt.

Goverments won't be able to roll their debt.  There will be no umemployment checks.  There will be no food stamps.  There will be lot less employment.

Your house will lose even more value, because nobody will take the credit risk of a borrower.

Go ahead, be bitter.  I am.  But don't be stupid.  Refusing to see the big picture is like cutting your dick off to spite an unfaithful wife.


Sun, 06/19/2011 - 11:49 | 1382481 Reese Bobby
Reese Bobby's picture

First rate satire...

Sun, 06/19/2011 - 13:50 | 1382704 jm
jm's picture


You know nothing about me, you fucking idiot.  And all you ever do is say stupid stuff that shows you know nothing about the issue.  Just shut up and fuck off.


Sun, 06/19/2011 - 20:38 | 1383383 ZeroPower
ZeroPower's picture

Ignore the trolls man.

Sat, 06/18/2011 - 20:25 | 1381379 Lord Welligton
Lord Welligton's picture


Well bugger me.

I didn't realise that CDS were essential for the efficient allocation of capital.

But then the East India Company never used them.

Who's calling the margin and who has the cash to meet the margin.

Sat, 06/18/2011 - 20:33 | 1381413 jm
jm's picture

You asked a question.  I answered.  Doesn't seem to be much use in trying to explain anything to closed minds.

Sat, 06/18/2011 - 20:51 | 1381446 Lord Welligton
Lord Welligton's picture

Where is the price discovery on banks, including the ECB, that hold Greek debt?

That was my question.

Thanks for attempting to answer.

Sun, 06/19/2011 - 11:37 | 1382459 oogs66
oogs66's picture

price discovery on what?   The CDS on the banks is very liquid.  BAC  168/172  6 tighter on Friday, JPM 81/84  4 tighter,  and GS  147/151.  

Those are 5 year prices for the banks.  They equate to values under SNAC.  Very liquid, very transparent and the closing prices should be publicly available on Markit website.

Curves are less liquid.  1 year CDS is 42/62 for BAC.  Although it is 20 bps wide, since it is only 1 year, that equates to about 0.2% bid/offer, similar to what a 5 bp mkt would be on 5 year CDS.


Or are you asking about price discovery on Greek CDS?  There is a market for that as well, though just like the Greek bonds, it is less liquid than it was.


5 year Greece finished Friday 1875/1975.  On a "price" basis, you could sell CDS at 35 points up front + 500 bps running, or you could buy CDS at 36.3 points up front plus 500 bps running.  That is a bid/offer of 1.3% of notional  (as the spread widens, the convexity means each bp of bid/offer is less than for a tighter spread name, so although 100 bps sounds like a lot, it is only 1.3%).  My understanding is that the bid/offer on Greek bonds in the 5 year tenor is at least 2 pts wide, so the CDS is more transparent and more liquid.


If you are saying that we don't know the exact outright exposure of each bank to Greece, that is true, but we don't know their exposure on the bond side either for most banks unless they made a specific disclosure. 

If your main concern is the all the counterparty risk the banks have, no we do not know it, but so far banks have actually demonstrated a pretty good ability to manage that.  AIG seems to have been an exception, but that was not allowed to play out fully. 

Bank financial reporting leaves a lot to be desired in my opinion, but that applies to things as simple as their loan loss reserves - can you tell which loans they reserved it against?  what is loan loss reserves and what is being squirrelled away for fraudclosure settlement? 


Sun, 06/19/2011 - 12:01 | 1382511 Reese Bobby
Reese Bobby's picture

I know who bails out the TBTF banks.  I know the potential regulation of derivatives was killed so that the TBTF banks could use hyper-leverage to print money until it all came crashing down.


Why should it take years to move CDS to an exchange traded platform where the taxpayer is not on the hook?  The answer is that the Global Bank Cartel that runs our Governments and controls our money supply is in no hurry.


You try to make CDS sound like Lloyd Blankfein's "God's work."  It is really just leverage.

Sun, 06/19/2011 - 20:42 | 1383400 ZeroPower
ZeroPower's picture

Poor argument. The taxpayer is not "on the hook" for CDS. The only logical argument is against bailing out TBTFs. Something which unfortunately the US gov was quite keen to do.

Sun, 06/19/2011 - 16:08 | 1382929 sgt_doom
sgt_doom's picture

"The point is that CDS allow an investor to hedge his exposure."

Negative, the point is that when an unlimited number of CDSes can be written against a particular category of bonds or a specific financial entity, and an unlimited number of commodity futures contract can be created as well, coupled with an unlimited number of investors allowed per hedge fund (in the USA, the Investment Company Act (amended) of 1996), you have unlimited potential for ultra-leveraged speculation.

Next question?????

Sat, 06/18/2011 - 20:09 | 1381345 Lord Welligton
Lord Welligton's picture

So. All that is being said here is nothing more or less than that CDS are traded on margin.

And margin may and will be called.

So what.

Does this make Greece more solvent?



The USA?


All margin products are Ponzi products.

Sat, 06/18/2011 - 20:16 | 1381368 scatterbrains
scatterbrains's picture

my take from the article is that even though US 10 yr trades at 3 the CDS on the same is sling shotting.

Sun, 06/19/2011 - 11:55 | 1382506 oogs66
oogs66's picture

so there should be no options, no futures, no shorts, and heck no ability to borrow money to buy stocks?  or homes?

All of those products have features similar to CDS, particularly options.

Sat, 06/18/2011 - 20:10 | 1381353 Reese Bobby
Reese Bobby's picture

"...faulty conventional wisdom that CDS was the cause for the implosion of AIG."

I'd like to hear the correct non-conventional wisdom on AIG.  Because you're right, I'm still walking around thinking AIG sold protection on sub-prime by the boat-load because they didn't have to mark to market or post collateral given their AAA rating...


And to me, "participation constraints, initial margins, variation margins and non-margin collateral," sound like 1980's portfolio insurance: they work until you get a cascade-like sell-off.

Sat, 06/18/2011 - 20:25 | 1381388 Tyler Durden
Tyler Durden's picture

AIG was going long the synthetic underlying. Since they were expressing unlimited demand, Goldman or whoever could simply continue issuing increasingly lower yielding cash paper which AIG would buy to collect the same yield that they collected by receiving the protection on sold CDS. The point is the instrument is not the issue, but the underlying decision making stupidity.

And furthermore in a normal world, if the government really wanted to reallocate profits in a somewhat fair way than merely defrauding taxpayers, it would take the profits made from buyers of AIG protection and use it to fund AIG capital deficiency. Of course, that never happened as it would mean Goldman, which in this case was spot in in predicting the housing collapse (ethics aside), would see a massive loss. This all goes to the point of endless moral hazard which as noted above, is the topic of a different post entirely, althugh is currentl being manifested in the cash market: instead of one organization selling protection you are getting every financial company buying up record amounts of debt issued by corporates at record low rates, many of which variable. How is that any different than what happened with AIG?

The point is the demand for risk is there, and it will always be met with one instrument or another.

If one wishes to blame someone for the AIG collapse, blame the Fed.


Sat, 06/18/2011 - 20:51 | 1381453 Reese Bobby
Reese Bobby's picture

I understand your, "guns don't kill people" viewpoint.


The sad thing is we can question whether the crew who blew-up AIG were even stupid.  Who went to jail?  Who had to disgorge profits?  Cassano looks to be doing quite well.  Sad...


Which speaks to your point on moral hazard.  The only lesson to market participants has been: if there is a risk you may fail, make sure you fail really big.

Thanks, (man I get so nice when I type to a Tyler).

Sun, 06/19/2011 - 09:52 | 1382294 falak pema
falak pema's picture

I find you "gayness" practically contagious when you speak to TD. No trolling and vociferous  name calling and lolling even want to know "so who went to jail?"...Now that is called "having a social conscience" you are no longer an advocate of Huntsville summary justice in the lone star state?

Wow, its raining unicorns...but there, I am dreaming ...of a white xmas of patriot's act repeal!

Sat, 06/18/2011 - 20:56 | 1381456 XPolemic
XPolemic's picture

I'm not sure why in a normal world you would forceably take money from Goldman and give to AIG.

Yes, AIG mispriced their risk premiums, but Goldman also failed to manage the issuer risk.

I say, let them all go down. How else are would you reset 20 years of capital misallocation and malinvestment?


Sat, 06/18/2011 - 22:02 | 1381621 narnia
narnia's picture

Tyler's "justice" + a whole lot more pain would have been served had AIG been rightfully forced into bankruptcy court.  This, of course, assumes AIG really "lost" all these bets definitively.  I'm still perplexed how they did if GSEs covered 100% of par for their "implied" guarantees on the underlying debt instruments.

Sun, 06/19/2011 - 02:52 | 1381995 XPolemic
XPolemic's picture

Correct me if I am wrong, but were the instruments underlying the CDS not MBS or CDO?

Can you tell me which GSEs guaranteed 100% of par on those instruments?

It's been a long time since I looked at this, but my (probably incorrect) understanding of what happened was this:

Goldman (and Bear and Lehman and everyone else) tranched mortgage notes together and issued CDO/MBS.

Goldman foresaw a housing correction, and so purchased CDS from AIG on primarily CDO/MBS.

AIG (rather stupidly) sold these CDS at increasing discounts because they thought the probability of default was 0, and hence it was free money all round.

Interest rates climbed roughly 425bips, bottom fell out of the housing market, subprime default rate exploded, causing credit events in MBS/CDO and subsequent calls on CDS written on said MBS/CDO which AIG couldn't cover.

Could you elaborate on which GSEs were backstopping MBS/CDO paper?


Mon, 06/20/2011 - 00:17 | 1383896 narnia
narnia's picture


This is the Fed's picture of real estate financing in the US:


If I am reading this properly, the total of all single family mortgages outstanding in the US in 2010Q1 was $10.7 trillion, of this:

$2.7 trillion was held directly by commercial/savings banks (which should not have been in a syndicated pool)

$0.9 trillion was held by non-financial individual / hard money lenders (which should not been in a syndicated pool)

$4.8 trillion was in MBS directly held by GSEs 

$1 trillion was in MBS still held outside the GSEs but guaranteed by the GSEs 

$1.3 trillion was in MBS held privately & not guaranteed by GSEs (pretty close to the amount purchased at near 100% par by the Fed, probably not by coincidence)

I'm just not seeing much MBS out there that would have been part of a syndicated pool, upon which CDS was issued, that was not guaranteed by the government.  My two cents on all of this from the very beginning was: the rating agencies gave these instruments AAA and AIG priced the CDS without even looking at mortgagee risk because of the government credit enhancement.  Given how it has all played out, you have to wonder whether the mortgagees not paying even qualified as a credit event.

Mon, 06/20/2011 - 00:37 | 1383969 XPolemic
XPolemic's picture

Given how it has all played out, you have to wonder whether the mortgagees not paying even qualified as a credit event.

Superb. I'm going to put that in my keep file.

What I didn't get from the link is what form the guarantee took. Was it similar to deposit insurance? Sort of like goverment mortgage insurance except that no one paid any premiums?


Mon, 06/20/2011 - 02:39 | 1384189 narnia
narnia's picture

FNMA, FHLC & GNMA provide fee based sureties, backed by the full faith & credit of the US Treasury, for MBS based on criteria defined by politicians.  These entities racked up pretty signficant fees using the government's credit to amass a brutally underwater multi-trillion $ MBS portfolio. (FDIC is also not free, it's substantially paid for by member banks).

Perhaps Goldman & others saw an opening to make these fees using a CDO structure. Maybe AIG looked at FNMA's past exposure in this game as low, so priced the CDS to allow the structure to work.  Perhaps the ratings agencies also looked at FNMA's past exposure to rate it.  Maybe this model was used for the lion's share of the $1.3 trillion non-GSE guaranteed MBS issued.  Maybe that's why the Fed bought all this stuff (if they, in fact, did) because they were exposed to it anyway with AIG.  

Mon, 06/20/2011 - 04:42 | 1384276 XPolemic
XPolemic's picture

So let me see if I have this right. The US Treasury effectively supplied a form of fee based mortgage insurance, which essentially guaranteed the underlying mortgage note, regardless of the LTV of the mortgage vis a vis the actual property.

Because these mortgages were essentially insured by the UST the following happened.

1) They gave anyone who walked in the door essentially any size mortgage they asked for (and sometimes a bigger mortgage than they asked for).

2) They tranched these notes up, and despite the fact that the borrowers were not creditworthy, the mortgage notes were, essentially because of the sureties provided by FNMA, FHLC & GNMA.

3) SURPRISINGLY, people with no job, no income and no assets experienced severe repayment stress when Greenspan raised interest rates ~425bps to halt the descent of the USD.

4) The subprime default rate exploded and the 30-90 day cashflow dried up.

5) Yada yada yada. US government steps in and makes good on it's sureties, everyone happy. Ok, not everyone.

Sounds to me like the collapse of socialism, not capitalism.


Mon, 06/20/2011 - 12:28 | 1385088 narnia
narnia's picture

The easing of credit standards (and, to some degree, the gamesmanship that went with meeting artificial government standards), the expansion of other homeownership subsidies (direct & indirect community development programs, tax incentives, regulatory control) & development oriented tax regimes caused a major earthquake in the demand & supply sides of real estate pricing.  The flooding of cheap liquidity backed by the US taxpayer in this asset class was the tsunami.

When the wave subsided, the US has a supply of ownership quality real estate that maybe 50% of the sustainable portion of our centrally controlled economy can support at historic interest rates.  

Valuations are inversely related to the interest rate.  When the interest rate hikes went into effect, it crumbled refinancing activity (which fueled what keynesians like to call "aggregate demand"), which caused an economic slowdown, which concurrently led to liqudity drying up & defaults, which led to liquidity injections, which led to price confusion, which led to panic, which led to bailouts, which led to more liquidity, which led to prologued price discovery...  which leads us to where we are now, an entire asset class in need of bankruptcy court.

The simple version of cause and effect is taxation (the state spending money, directly or indirectly, through subsidy, regulation, or printing money) leads to inflation which ultimately deflates to the price it would have been without the taxation.

Mon, 06/20/2011 - 18:50 | 1386730 XPolemic
XPolemic's picture

Yes ^^

The simple version ... the state spending money

As I said, it looks like socialism has collapsed.

Finally, the second world war can come to an end.


Sun, 06/19/2011 - 07:49 | 1382186 A Man without Q...
A Man without Qualities's picture

The problem with AIG was far broader than just AIGFP.  There is circumstantial evidence that the more traditional insurance divisions where suffering from a lack of capital adequacy, even when AAA rated, that was being hidden by staggering reporting dates and moving assets around the divisions as needed.  AIGFP was providing much needed cash flow by buying synthetic high rated, but high yielding instruments to give the cash flows to keep everything looking in order, but though people knew it was out of control, nobody could stop it.  The massive injection of capital into AIG, while covering the losses at AIGFP was also about bailing out the other business areas.  It has been useful to blame Cassano and his out of control division, but the rot had set in far deeper than that..

Sun, 06/19/2011 - 13:27 | 1382666 unununium
unununium's picture

"staggering reporting dates and moving assets around the divisions as needed."

Just as banks in the old American west would move the cash/gold to the next vault to be inspected.

Repo 105.  Crime, plain and simple.

Sun, 06/19/2011 - 11:40 | 1382466 oogs66
oogs66's picture

the trades AIG were structured one off trades.  they were illiquid.  they were not transparent.  AIG amended the contract often so that the banks could call it CDS so they could receive beneficial regulatory capital treatment, and AIG FP called it insurance so they could get beneficial regulatory capital treatment. 

So the trades AIG did are nothing like the plain vanilla single name or cdx index trades that comprise the vast majority of CDS.  And it was actually AIG FP that was the counterparty backed by AIG, another trick used to gain some form of advantage.  AIG and AIG FP was a complete disaster and the banks underestimated how much it could cost AIG, but even more importantly, under estimated how quickly AIG could collapse under their demands for collateral once AIG was downgraded.

Lots of problems with AIG, but the credit derivatives they were doing were not really what the CDS market is all about.

Sun, 06/19/2011 - 13:28 | 1382674 unununium
unununium's picture

"the banks underestimated how much it could cost AIG"

Come on, are they geniuses or lambs?  Can't be both.

The banks knew they would be ramming through a bailout for AIG eventually.


Sun, 06/19/2011 - 16:13 | 1382935 sgt_doom
sgt_doom's picture

TD: ".. blame the Fed."

Naaah...I would blame the Group of Thirty, who suggested the removal of all "legal risk" and JPMorgan Chase, where the CDS was created, and the Supreme Court, which found in favor of fraud in the 1994 Central Bank of Denver v. First Interstate Bank of Denver, which stated that financial institutions, attorneys and accountants can't be held liable for aiding and abetting securities fraud.

Next, I blame the US House of Representatives for unanimously passing the Private Securities Litigation Reform Act of 1995 which made that Supreme Court decision the law of the land.

Plenty of blame to go around, as well as blaming the Fed -- which I agree with as well.

Sat, 06/18/2011 - 20:12 | 1381360 swissinv
swissinv's picture

fully agree and yes of course the ECB won't go bankrupt -> inflation bitchez!

Sat, 06/18/2011 - 20:19 | 1381361 Pure Evil
Pure Evil's picture

"there is $5 billion in net notional daily margined risk exposure on the Hellenic Republic "

Like, wow man, I carry that around in my back pocket every day, so no biggie here. (Hopefully, by the time Berskank finishes printing I'll be able to carry a $1 Trillion FRN around in my back pocket, but no hurry Big Ben).

"but where daily steady cash outflows to satisfy variation margin mean that banks have "overreserved" for an event of default ..."

Uh uh, and exactly whose money was overreserved? Theirs or,

"after all the ECB will just print more €), forcing a self-fulfilling liquidity run prophecy."

Or, will it be Big Ben Stanky at the FedRes or the ESF over at Treasury.

Hopefully, they aren't using depositers monies to cover these casino bets.

I can only ponder if that was why Glass-Stegall was written into law.

Hmmm, ....., pondering, ....., pondering, ....

Sat, 06/18/2011 - 20:35 | 1381396 Lord Welligton
Lord Welligton's picture

I can only ponder if that was why Glass-Stegall was written into law.

I can only ponder if that is why Glass-Stegall was written out of law.

Sat, 06/18/2011 - 21:08 | 1381473 Pure Evil
Pure Evil's picture

Yes, its amazing how the growth of derivitive contracts grew exponentially once Glass-Stegall died most gloriously.

I guess all that money sitting in depositors accounts was just too much to pass up. I mean it was just sittin' around doing nothing, all the better to put it to a good use.

I mean the banks know what's best for us, we're just unwashed backward hillbillies without any formal education, and like the government, they're here to help us grow wealth from the few pennies we've managed to save.

Sat, 06/18/2011 - 20:21 | 1381370 XPolemic
XPolemic's picture


Is CDS written only on Treasuries or also on Muni bonds and commercial paper?


Sun, 06/19/2011 - 12:06 | 1382526 oogs66
oogs66's picture

there is a CDS market for munis, though my understanding that it is only liquid for some of the biggest state's general obligations (NY, California, etc.).  There is a 50 name MCDX index, but even that is fairly illiquid with a bid/offer of 3 to 5 bps, compared to 1/2 a bp for IG CDX index.

Commercial paper, is typically issued by corporations and that would be subject to standard corporate CDS.  The standard CDS contract revolves around "borrowed money" which would include CP, Bonds, and loans.

Sun, 06/19/2011 - 13:31 | 1382673 XPolemic
XPolemic's picture

Thanks for replying, great info. I guess what I was getting to is the 136% increase shown in the chart above on total CDS written on US paper. Or more specifically the gross notional.

Is that only sovereign debt, or does it include muni, institutional, etc.?

Thanks again for replying.


Sun, 06/19/2011 - 21:17 | 1383451 ZeroPower
ZeroPower's picture

Sovereign. As oogs mentions above, different contract for different type of debt and thus CDS.

Muni CDS market is still small, last number i saw around $60Bn versus overall muni bond market at ~$3Tr (according to WSJ).

Sun, 06/19/2011 - 23:34 | 1383772 XPolemic
XPolemic's picture

Thanks for the clarification. Hmmm ... that sounds bad.

I would hazard a guess that the market believes that the debt ceiling won't be raised, and the UST will default. I thought Timmay still had government pension funds he could steal. I wonder what the burn rate on those are.


Sat, 06/18/2011 - 20:39 | 1381419 prophet
prophet's picture

Money market funds in US hold about $300B in european bank short term paper. 

Sun, 06/19/2011 - 11:58 | 1382516 oogs66
oogs66's picture

Right, this is the sort of contagion we face.  Greece defaults.  Banks lose money.  Ireland defaults.  Banks lose still more money.  Banks start to default, money market funds break the buck.  All hell breaks lose.


That is the contagion that is likely to hit, and CDS may play a small role in moving the pieces around, but the real contagion will be, just like in sub-prime, that the people who borrowed money can't repay it, and the lenders were not properly prepared for it.

Sun, 06/19/2011 - 00:17 | 1381427 slewie the pi-rat
slewie the pi-rat's picture

some myths are hard to debunk, especially when the peanut gallery knows didley squat,  BiCheZ.

it's The Margin Trap starring hayley mills as lindsay lohan and lindsay lohan as hayley mills.  very confusing to the leveraged, according to the reviewers, dodd and frank.

soon, we shall have a discussion as follows, between a bankster and a loan applicant:  why do you want the loan?

to buy a business.

i'm sorry, we don't loan to buy things, only to pay for them.

well, to pay for the business, then.

i see.  and when did you buy the business? 

i want to borrow the money to buy it!

if you don't own the business, we can not finance your losses.  clearly, you don't know didley squat about banking, sir.

so now, you can see what tyler's myth debunking is up against, here...

Sat, 06/18/2011 - 20:48 | 1381432 CharlieBitMe
CharlieBitMe's picture

So Tyler, what are you really saying? Sell the CDS and sell the bonds? :) How does one assess the recovery rate on a failed socialist state? When the default occurs, what is it that you'd recover? Also, no Citi on the list? Something's not right.

Sat, 06/18/2011 - 21:09 | 1381487 Peak Everything
Peak Everything's picture

I am well educated, reasonably bright, have been reading ZH for over a year, and still do not understand.

Guess I'll have to fall back to my default mental model:

Too much debt. Growth to support debt not physically possible. What cannot continue, will not continue. Expect reduction in global wealth. Try to protect what little wealth I have.

Sun, 06/19/2011 - 07:35 | 1382173 mogul rider
mogul rider's picture


Sun, 06/19/2011 - 13:41 | 1382695 XPolemic
XPolemic's picture

I am well educated, reasonably bright, have been reading ZH for over a year, and still do not understand.

I think it's not that difficult to understand. Financial Markets are pretty much like ZeroHedge. A place where people spend their day swapping opinions. One person might have an opinion that Greece is fucked, another might think that things are not so bad. They take their opinions to the financial markets and say "Hey, do you have anything that reflects my opinion that I can buy (or sell)", and sure enough, most of the time, they do.

The problem in financial markets, much like on ZeroHedge, is when people become too attached to their opinions. Usually the market brutally and unsentimentally disavows them of their attachment, but occaisionally, a group of frightened little people who all went to the same schools, and learned the same sense of unjustifiable self-importantance and sense of world-saving-changing mission, find themselves at the top of the decision making apparatus and decide that they are going to use everyones money to enforce their opinion on the market. Now is one of those times.

Too much debt. Growth to support debt not physically possible. What cannot continue, will not continue. Expect reduction in global wealth. Try to protect what little wealth I have.

I guess it depends on how you define wealth. Personally I feel wealthier when I am teaching my son about dinosaurs and evolution than when I am getting paid to debug Monte Carlo simulation code or IR Swap settlement risk models. But that's just me. YMMV.



Mon, 06/20/2011 - 11:53 | 1384995 Peak Everything
Peak Everything's picture

Nice thoughts, thanks.

Sun, 06/19/2011 - 16:15 | 1382939 sgt_doom
sgt_doom's picture

"..and still do not understand."

Or, to put it even more cogently, those scamming debt-financed billionaires made a fortune peddling securitzed debt, then they run off with their profits, while socializing all their debt onto the rest of us.


Sat, 06/18/2011 - 21:26 | 1381532 zorba THE GREEK
zorba THE GREEK's picture

 We will all find out what the real risks are and how the

 cds will play out soon enough, because its about

 to go down. Greece is not the precident. Iceland was .

 And we know how that went down. Riots trump

 previous greek gov agreements with IMF and EU.

 NO need to speculate now. Just observe and take

 notes because within 6 months its coming home.

Sat, 06/18/2011 - 22:35 | 1381693 Cman5000
Cman5000's picture
UK banks abandon eurozone over Greek default fears UK banks have pulled billions of pounds of funding from the eurozone as fears grow about the impact of a “Lehman-style” event connected to a Greek default.
Sat, 06/18/2011 - 22:49 | 1381711 Cman5000
Cman5000's picture
Greek Debt Restructuring Off the Table: EU Official

A restructuring of Greece's 340 billion euro ($481.5 billion) debt is not on the agenda and would damage the country's credibility on bond markets, the European Union's internal markets commissioner said on Saturday.                     Forcing Greece's private creditors to take part in an upcoming aid package would count as a restructuring and is not being considered either, Michel Barnier told Europe 1 radio.

"This question of a restructuring ... is not on the table," he said. "It would only postpone the problem and in the wake of a restructuring Greece would face exactly the same difficulties and would no longer have any credibility to borrow."



Sat, 06/18/2011 - 23:18 | 1381748 bsdetector
bsdetector's picture

After following the Greek drama for some time now it seems to me that the ECB and every other government that has a constituent that could lose money is going to throw money at the Greeks regardless of whether they want the money or not. If the cash flow is disrupted, god forbid, constituents are going to lose. And forgive me for asking but what is the payment mechanism for distribution of the bailout funds? I bet the payments are direct to the bondholders from the bailing governments. Who could take a chance on the Greeks to misappropriate those bailout moneys. And what is the contagion every one is screaming to avoid... is it the fear that if too many people see that you can shirk a debt many others will follow?

Sat, 06/18/2011 - 23:21 | 1381753 nathan1234
nathan1234's picture

The entry of Greece into the EMU with false data was aided and abetted by Goldman Sachs.

It is imperative that Goldman Sachs be taken out immediately= Close them down and liquidate the firm.. If the US Govt or the EU do not take action it is time for people all over the world to take action- STOP DEALING WITH GOLDMAN SACHS.

Sat, 06/18/2011 - 23:40 | 1381789 XRAYD
XRAYD's picture

The last quote I read was that it costs $10.5 million dollars to insure $10 million dollars of Greek debt for five years.


Sort or like buying life insurance in which YOU pay the insurance company when you die!

Sun, 06/19/2011 - 11:45 | 1382468 oogs66
oogs66's picture

LOL!  that is too funny, but also wrong.  Greek 5 year CDS finished Friday 1875/1975.  That equates to a market of 35/36.3 pts up front +500 running.  So it would cost $3.6 million up front and 500k running to protect against $10 million.

Sun, 06/19/2011 - 00:18 | 1381842 unununium
unununium's picture

"CDS is nothing more than a low margin synthetic method to express a bearish position on an underlying credit"

CDS is nothing more than unregulated insurance, and the foolishness of allowing that was proven a long time ago.  Protecting you neighbors house, then burning it down.  Bankruptcy fraud.  All figured out a long time ago.


Sun, 06/19/2011 - 11:47 | 1382475 oogs66
oogs66's picture

so we should not have options on anything?  futures on anything?  short positions on anything?  with your analysis that is the only logical conclusion, and if anything the stock price goes to zero long before the bond price so equity options should be banned long before CDS.

Sun, 06/19/2011 - 12:49 | 1382607 unununium
unununium's picture

I cannot ruin the world with my options account because of strict equity and margin rules.

CDS must be regulated, not banned. 

It's way beyond the argument stage now.  Grand experiments on the world stage have shown and will continue to show the foolishness of allowing the finance industry to regulate itself.  

Agency fraud, arms-length scams, the list goes on and on.  The pigmen have no rules and will always double down when the alternative is death.

Sun, 06/19/2011 - 00:51 | 1381890 snowball777
snowball777's picture

It isn't the derivatives on Greece, but that of the people to whom the greeks are knee-deep in soon-to-be-haircut debt that will bring the $600T deck of cards tumbling.


Sun, 06/19/2011 - 13:01 | 1382624 unununium
unununium's picture

+600 warehouses of pallets of stacked hundreds, two high.

Sun, 06/19/2011 - 01:08 | 1381897 jmc8888
jmc8888's picture

I'll take a shot, sure hope it doesn't hit the broadside of a barn. If so, oh well. Fuck it.

So (besides the contagion of an EOD through the ECB or other central bank being insolvent to lend as last resort due to markdowns, given what is marked down is the collateral the ECB, Fed, or other leverages/prints against, until additional electronic printing occurs or it's authorization to do so) the crack will more likely come from the banks that are involved in other so far deemed 'safe'-r countries that have more room to run from their current position of value I suppose (at current low levels of perception in happening), and thus a sharp increase in the daily margin (or multiple daily calls) required to meet it from large swings of those 'safe'-r swaps (to a new higher level of perception in happening) against said banks cash, and easily liquidated positions/assets within a freezing liquidity market context (or regular context...either one...or one causing the other) is more likely in causing a bank or other entity to become insolvent than Greek's itself CDS daily (or multiple) much smaller margin calls?

Not necessarily from the delta from day to day (or hour to hour) of Greece that has already run so far on a smaller scale than the big ones who haven't yet moved much?  Makes sense from a (poor choice of word) probability perspective and in total comparison. 

My viewpoint is that either can be it, or given what in totality can happen if Greece were to move to a full EOD.  It won't cause the default, it would create a secondary event the moment of it. Which in turn could invalidate all [or partial] written swaps from that bank and across all [or some] levels it conducts business in where cash collateral equivalent is not held in reserve (less what the credit they hold against can be sold, or other asset they put in it's place in case of a 3rd party swap). 

I.E. If the total rammifications of Greece is that all margin calls are increases to the point something breaks, and the bank that sold you a swap on say Australia (never mind why you are holding it), that would be worthless because the other destroyed any ability for it to be paid and given that it may be multiple banks (especially the fear of acquiring a whammy card) others would not be able (or willing) to take on that risk (and from what collateral they may get to take it on given all the other claims the original bank[s] would be liable for).  So holding in Greece Swaps would suck if Ireland pulls the plug, and holding Irish swaps would suck if Greece pulls the plug, if the bank held enough to have a problem.  I think that's what I'm getting at.  Only the actual first default gets paid, in my estimation, the rest is potentially zeroed at that specific bank of others it wrote, more so if you consider secondary contagion hitting the same trading day. I guess a big part is how fast the contagion spreads.  I think when it happens it will be an order of magnitude faster than last time as a guess of mine.

Couldn't also Mark to Infinity collateral for 3rd party swaps (where the bank issuing said swap is not holding the credit underlying it) be a factor if that collateral is say housing sold to it by a florida/az/vegas or spanish caja? Perhaps that wasn't affected by the MTI debacle. Obviously not sure if that was infected with contagious parts so to speak by allowing it to be collateral.

Given deposit outflows, stock valuations, the drop off within a liquidity crunch that can be raised, and many more factors, that as of right now are escaping me or perhaps that I don't have, but can plumment in conjunction with a EOD on Greece or in tandem with other sovereign nations weakening (but not at first having their own EOD) at the same time, then that could all together in a major move across from perhaps even the perception of an upcoming EOD could do it and render many instruments locked up in the bankruptcy courts and subject to a hierarchy of creditors that may not be so friendly to the swap holder.

So Greece in total (for which the Greece swaps are but a small part of) plus everything else would bring down certain systemic banks which in turn would throw a cog in the other aspects of the derivatives machine (like fx) which then would make everything virtually unpayable (perhaps that only happens after one's initial cds position has cleared?). Perhaps I'm thinking on end of day settlement since I feel that when the bow breaks, much will happen in one trading day.  (before much more happens across...the length of time it takes above one day)

But if the swaps are insuring against a large portion of what they have credit in it, doesn't that mean the turn aisle needs to be big enough to handle the collateral call during an EOD comparable to the amount defaulted on for which there is insurance written against that needs to be paid out (which could be 0-100 percent of that defaulted upon but probably within a much smaller range the percentage of said class of bonds defaulted upon), and the pereception by the market of what more it could face imminently, and thus if 10 percent of the bonds that are insured have an EOD (let's say across all time periods), then the liquidity needed given a constant stable value (and not dropping) by the above constraints and thus that turn aisle would need to be much larger than the market is ever realistically expected to provide? For that example it would maybe be ~15 percent of the bonds across time period classificaitons.  See fed shitting it's pants and pushing trillions to europe like before, although not necessarily for JUST that but the results of what that triggers after a time period of them being 'asleep at the wheel' (i.e. not going into WHETHER they should...I think we all know where we stand)?

I guess another way to put it is can highly levereged entities be expected to be able to cough up said amount that is possible by the nature of selling these swaps given all the calls that could come at the end of the day? I would suspect that answer is no.  If true, in essence wouldn't that be a case that these swaps should not be able to be sold by these banks, especially when with Glass-Steagall in place, they would not be able to at all and only the AIG's which can be allowed to fail would be able to issue them and be separate from the banking industry.  (as of now they are obviously all intertwined risking other cross-linked derivatives of other stripes, like fx, or vice versa. Not to mention of course everything contained with these entities that are intertwined [that can be intertwined] because they are not protected and thus have been co-mingled like deposits)

My thought was the clusterfuck that happens would bring about the bigger (as opposed to merely insanely big) 'S' Systemic risk, across the macro of the industry, thus making the finger pointing moot, as bankrupt banks can't pay and many things which close at the same time can't all take what is readily available or raised by selling in time to stop the contagion or a major drop in value in order to create the amount of capital necessary to satisfy the clearing.  Thus big (as)S Systemic. Especially if the central banks are technically insolvent (or some of them).

Because somehow I feel if everything (that is capable and minus FDIC [which is broke but that's another story]) was tied up because the bank failed, the individual CDS investor would appear to be lower on the totem pole then another bank in the derivatives chain, specifically Inter-Alpha group types typically termed TBTF's, unless a bailout is given, which if happened would be promoting the process to occur all over again.   Especially in the context that there is no more moral hazard, and that it appears was what happened before. So once the market knows, many might purposefully jump onto the trade to screw the central bank of your choice. We've all see this song and dance before, and while it may be a risk, if the past is precedent, and the pitchforks aren't out (or close to it), then they'll be paid off as long as the fed and ecb and others can still print.

At some point ECB and Fed can't print, although I don't know when or what level of pitchforks it may or may not be required to stop them from doing so, especially when looking at the trillions they poured into europe in 2008.

Also I'd think perhaps that only one central banker in the chain needs to defect from the process to bring it all down.  At some point if the numbers get to tens of trillions or more, or more specifically a few trillion a day in margin calls, after a few days, one may (but probably not).  When any of them do that, or it becomes politically/physcially impossible for it to be done, or perhaps even merely delayed an unspecified time period, certain things can be bankrupted from and during that, given the contagion effect ongoing while your process is clearing waiting for collateral to be raised that cannot be done.  Selling one's own position off to a bigger individual idiot in time might be one's only recompense instead of waiting for an official payout from that entity or clearing house.  One that best is done BEFORE noah's flood. Good luck with the timing.

Besides the U.S., I'd think Italy, Spain, and Brazil would also be highly suspect to great swings in their CDS, and be the type of delta change events ZH is I believe warning us of, so any of the bigger players having big intraday swings could bring it about compared to Greece itself.  U.S. debt ceiling could cause one, small now, but in days before what august 2 or 17 or whatever this could change dramatically? What if central banks themselves get involved and jumped on board? Other than that, Spain, Italy, Brazil, are big chunks, and perhaps France through Greek Exposure?  Note to self, like ECB, the fed sure holds alot of itself, like ECB owns itself in Greek Bonds, since the difference between the US and fed while Greece being in the union is basically nothing.

But I guess the bigger threat perhaps you are pointing out is the fx market?  Which makes Greece and all bank swaps look size wise like peanuts.  So the swaps based on these fx amount to where in comparison in size scope and position along the continuum? Who is lower on the chain? Would it be those at artificially high/low positions where the delta is poised to be the greatest, i.e. Euro at it's inflated level, amongst others possibly bigger 'risk' that is not seen and not accounted for right now.  Would these swap events be enough of a catalyst to cause these swaps to move significantly enough to cause a problem? My guess is yes.  My guess is this is the biggest area of concern for eventual metastatic contagion.

At the same time conceptually, if everyone is using the instrument wrongly, then while teaching people the correct way to use it would inherently drop off its usage given a normal world at stage 0 or 1, it is too late for that, and wouldn't not allowing such practices be a better way, to deal with what may be termed as near the end stage? Aren't we there as we are levered up amongst everything to insane levels?  And as such at any stage between any definition we try, someone could profit immensly between the definition and reality because it is too complicated for the idiots to understand or reasonably expected to given the volume going on?  

Plus shouldn't we want our banks thinking of how to create loan opportunities for business instead of focusing on this crap? (especially since THEY have the monopoly on it given no central state credit directly to business)

It's the people that use the instrument, but if everyone is using them wrong or fraudulently, and the fed pushes the moral hazard allowed button, is it really worth having that option? Is there any way one could expect human beings who think 'greed is good' could do in any other way? If it isn't nailed down in regulation, and the public's not lighting the ass of the regulator then no, I don't think that's even a possibility.

Wouldn't the amount used in daily collateral for all the derivatives be a sizeable amount, literally trillions a day sloshing around offset the widening spreads be better put into a real physical economy? Not to mention the risk we are currently facing given they exist in the first place.  So capital misallocated to this + the risk of losing all/most.

While spreads are reduced in the short term, until moral hazard encouraged by the fed through policy levered up everything to the hilt, is it really worth it, and can it be done in any other way, since history is showing with the fed backing it, it seems impossible to contain? I understand farmers using it for their crops, but beyond actual usage for actual positions I don't see why it should be allowed beyond that.

If the fed hadn't encouraged it through it's moral hazard encouraging policy, the instrunment would not be abused like it is.  However aren't we now caught in a catch 22 now? If we were to change such policy all of it is made worthless, and thus that is why the fed perpetuates the ponzi on the outside, while on the inside it is taken advantage of as long as it continues? The alternative is that stuff collapses if we were to just slice it out without a Glass-Steagall style reorganization (or collapses on its own) for an organized run down and removal from the system without directly affecting it, and the time factor of markets open while this process is occurring.  (oh still a deflation moment, but a managed one)

Personally I feel Glass-Steagall would do a great wipe job of this, and would touch all things derivatives that (don't have legitimate uses) that have been enlarged, contorted, and co-mingled into pretty much everything making a systemic breakdown a 'when' event, not an 'if' event.  0 or 1.  It's 0 until it's 1, and the 1 is coming. 

If I'm wrong on some of it, eh, at least I try to make sense of it.  But either way Glass-Steagall needs to be in our future.  The separation from gambling with capital, from business loan origination [with a credit system focus style origination to break the monopoly from banks] and deposits, needs to occur.

Sun, 06/19/2011 - 02:06 | 1381963 unirealist
unirealist's picture


Sun, 06/19/2011 - 02:39 | 1381986 damage
damage's picture

If you just end the bank subsidies (central banks, discount window, TARP, QE, etc, etc, etc), Glass-Steagall is meaningless.

Of course if you still want a shitty central bank then yes, Glass-Steagall is probably a good idea. However, I prefer just ending the bank subsidies and then you don't have to worry about them gambling with what is essentially stolen from the taxpayer, or anyone holding the currency.

Sun, 06/19/2011 - 09:55 | 1382297 falak pema
falak pema's picture

One helluva barn door to aim at!

Sun, 06/19/2011 - 02:35 | 1381984 6_7_42
6_7_42's picture

Bullshit acronyms aside, CDS is INSURANCE. Selling insurance is the lowest, sleaziest form of financial transaction as any historian of finance knows well. It's why insurance salesmen are more loathsome than used car salesmen. It is why the insurance industry is so massively regulated: it breeds criminal behavior and incites the lowest form of financial buggery. All CDS is bullshit. Will the house let you sell insurance on the bust of the player next to you at the blackjack table? FUCKING HELL NO! The pirivilege of selling a worthless product is what the house does best. When invesment bankers became sellers of insurance, the object of the insurance and anti-insurance (buying life insurance and then hiring a hitman to off the subject of the policy) we were all fucked in the ass, but just didn't know it until the roofies of the "booms" wore off. Fuck the DTCC. CDS is worthless shit masquerading as a "financial innovation".  "Zero Hedge?" Take a mother fucking risk! You dribbling cunt. Nobody gets to invest and win every time. That's why it's an investment: you could lose your money. Imagine that!  But no, we got this shit called CDS and it means if you win you win, and if you lose then someone else loses for you! Nobody loses! And by the way we take 10% off the top for our trouble.  Jesus what horseshit! Gimme some beta protection against that gamma lemma i-a-ta-pi theta! Only a trillion to back a billion! What a deal!  /*rant off*/

Sun, 06/19/2011 - 02:42 | 1381989 damage
damage's picture

Yeah man... all insurance is evil... and the government has nothing to do with the fact the insurance market sucks cock either.

Very sound logic, sir.

Sun, 06/19/2011 - 02:58 | 1381998 6_7_42
6_7_42's picture

Insurance is not evil, just the seduction of selling it and not keeping the capital to pay off when the unforeseen occurs. In most cases, for most customers, the products bought and sold are of no value. Hence, the oracle cunt of omaha loves the business so much. Make money selling nothing, then when the big payout comes due, suck on the public teat. Nice business to be in if you can!

Sun, 06/19/2011 - 03:11 | 1382008 damage
damage's picture

Ah, I did re-read your rant. Pretty much... I still like how I can watch CDS markets to get a good idea on how close a country or entity is to default, though.


 SYMBOL          TITLE                PRICE     CHANGE             OPEN      RANGE
 CPGB1U5:IND     Portuguese Republic  791.31    -18.106 (-2.237%)  791.31    779.65 - 802.97
 CITLY1U5:IND    Republic of Italy    174.61    -7.405 (-4.068%)   174.61    173.29 - 175.93
 CT777651:IND    Republic of Ireland  770.72    -33.754 (-4.196%)  770.72    757.55 - 783.88
 CGGB1U5:IND     Hellenic Republic    1,925.50  -147.588 (-7.119%) 1,925.50  1,861.33 - 1,989.67
 CSPA1U5:IND     Kingdom of Spain     288.72    -11.476 (-3.823%)  288.72    286.40 - 291.03

(the higher the price/premium the more likely they are to default according to the CDS market)

Sun, 06/19/2011 - 03:30 | 1382024 XPolemic
XPolemic's picture

Here is what I don't get about CDS.

Lets say you come to me and say "I've got liver cancer, and there is a 99% chance I will die within 3 weeks, and I want to buy a 1 million dollar life insurance policy, how much is the premium?"

I would most probably reply "1 million dollars."

But if some investment bank goes out to market with the story that they lent a billion dollars to Greece, and there is a 99.9% chance Greece won't pay it back, why would anyone sell you a CDS for anything less than 999 million dollars?

How is it that there is such a large arbitrage between the CDS spreads and the actual risks? Could it be because the chances of estimating the credit worthiness of any entity, at any future point in time is no better than rolling the dice?

Or is it a difference in the information available to the participants in the market i.e. information arbitrage? Aren't financial markets perfectly efficient?


Sun, 06/19/2011 - 12:11 | 1382486 oogs66
oogs66's picture

first, why do you think there is such an arbitrage?  Greek 5 year CDS is trading around 35 points up front plus 500 running.  That is with ECB officials all saying they are trying to avoid triggering CDS.  What is the likely recovery going to be?  50 cents on the dollar?  40 cents?  If there is a credit event right now you would have a gain as the CDS would price to where the cheapest to deliver bonds trade.  If a restructuring is accomplished without trigger CDS, your CDS is likely to go a lot tighter.  Right now it doesn't seem like it is obviously mispriced.  Greek bonds are not trading all at the same price.  The curve is inverted, so 2 year Greek bonds yield more than 10 year, but the price is still higher.  If a default was certian, then all the bonds should trade at the same price.  They don't, so you have to believe the market as yet hasn't fully bet that Greece will default - which makes some sense given the effort of the EU and ECB and IMF to avoid that.


secondly, why is your anger at CDS?  it is the bondholders who lent too much and are the reason for the bailouts.  it is just plain and simple dumb lending that caused the problem.  maybe you feel better protecting your cute little neighbourhood idiot banker who lent too much to someone who couldn't pay and blaming it on CDS, but you are missing the problem!  Stocks don't go to zero because someone shorted them, stocks go to zero because they are worthless or bankrupt.  Same for CDS.  The losses that are in the banking system related to Greece are about 95% related to lending to Greece and 5% from CDS done on Greece - though the reality is 100% of the losses are related to lending because on CDS one side pays, the other receives, no net winners or losers.  The only true losers in a default/restructuring are those who lent actual money in the first place.

Sun, 06/19/2011 - 23:09 | 1382717 XPolemic
XPolemic's picture

first, why do you think there is such an arbitrage?

Mostly because of AIG mispricing their CDS. My understanding is that Goldman noticed diminishing returns on mortgage backed paper in the front office P&L, even while the VaR remained unchanged (because the pricing model used the credit rating on the underlying for the mean time to default). My understanding also is that AIG did NOT notice that change, hence they underpriced the CDS they were selling.

secondly, why is your anger at CDS?

I'm not angry with CDS. If you look for my other posts I am somewhere between neutral and confused as to their utility. You can buy a put option on a bond (American OR European if you have a time horizon). You can buy a put option on a bond future. I guess the only difference between that and CDS is moneyness (I assume CDS is struck at par?).

What do CDS markets get you that bond options, bond futures or bond futures options do not?

(edit: I forgot to mention caps, floors, caplets, swaptions, all of which allow you to take a position against issued sovereign paper)

Sun, 06/19/2011 - 16:17 | 1382943 sgt_doom
sgt_doom's picture


Sort of, but I would really consider it:

Insurance fraud!

Sun, 06/19/2011 - 03:59 | 1382042 Dreamwalker420
Dreamwalker420's picture

First, to jmc8888, your comment was enlightening.  A complicated read, but none the less informative.

Second, CDS is insurance ... but that is exactly why the definition of the word "is" is still up for debate.

Third, systemic collapse is the end game of the entire global financial system.  The government's that exist today would not likely survive the ensuing turmoil of worldwide rioting.  As a creditor, how do you "restructure" the debt of a debtor who has no ability to repay the debts?  Prior to the invention of CDS, default exposure was limited to the entities in a contract.  CDS creates a level of inter-connected dependence ... Greece falls, then France and Germany fall, then the ECB goes bust, and the Fed and PBOC both implode as well.  We now know that the domino effect will occur in a short period of time ... and that world leaders are determined to prevent a systemic collapse.

Fourth, what is the relativity?  For me, I get up each day and go to my office to trade paper and ink.  I buy paper that I know will likely loose it's value at a large enough discount to sell it to someone else within a delicate time period.  Sometimes I'm wrong; either the underlying paper actually appreciate's in value and I loose potential profit, or the underlying paper looses value faster than my ability to churn it to the next guy.  I'm just looking for my 20%.  Assuming a systemic collapse occurs, I am suceptible to the consequences of inadequate preparation ... I don't own land, I can't own a firearm, I don't have food storage and I have no gold to speak of.  When a people becomes broken from the abuse of the ruling class, it ends with violence.  A systemic collapse would lead to rioting; as the supply of basic goods and availability of services become disrupted by a breakdown in commerce.  And since rioting is akin to anarchy, it seems obvious to me that inflation is the only method then that governments and central banks will have to alleviate the massive losses from CDS exposures to a credit event, Greece or elsewhere.

My goal then as a small investor is to seek a hedge against inflation with the expectation that governments will continue to print their way to solvency.  Steady inflation that offsets the massive deflation lurking from the shadow banking system.

The market can remain irrational a lot longer than you or I can remain solvent.

I expect the market to remain irrational, with or without a credit event in Greece.  At the point at which a systemic collapse of international finance does occur ... in the absence of government I'm sure my priorities will change dramatically.

I was shocked September 15, 2008.

I was disgusted September 16, 2008.

I was disappointed March 9, 2009.

I have no idea when I lost faith in the Rule of Law, but I certainly no longer expect rationale to dictate the environment.

Sun, 06/19/2011 - 04:03 | 1382044 Andrew Wiggen -...
Andrew Wiggen - Speaker's picture

I have a question - and I'm new at posting here. Why doesn't the EU, Germany, et. al. take the money they are going to throw away by "loaning it" to Greece and 1. use it to pay and extend (refinance as available on similar terms) the Greek debt for the next five years, and 2. cut Greece off from any more debt - by making them actually seek market rates for any future junk debt.

It would be a naked kick of the can five years down the road - but by then, Greece would almost certainly not be the number one problem. By not giving away more money now directly to Greece, the EU wouldn't need to impose 'austerity' measures on Greece; they'd come naturally. And, while the implosion of gov't largesse would ultimately be good for Greece (ala Mises dealing with the problem sooner than later), in the near term, it would probably send a chilling message to the other PIIGS still interested in catering to the 'suck up' class to avoid that particular political route. I think it would avoid the 'contagion' fear.

Greece might jump ship, default and disavow their debts as a backlash, but I think the spiral out of the EU in economic disgrace would still avert contagion fears and the money that was going to be thrown away in "loans" would be used to sustain their debt from external sources for five years so that the default wouldn't have immediate consequences. Also, and of course, vague assurances of dealing with the rest of the debt at a later time, or imposing the debt back on Greece 'down the road' in order to regain any future credit rating, etc.

I think this could be done in a way to steady the fear of contagion and send a chilling message that the EU is going to play hardball. IMHO, placating Greece is a larger morale hazard for contagion than letting if fail so far as the other PIIGS are concerned. So, if they are going to fail anyway, and they are, then why not use that failure to send a not so subtle warning to the others.

I think many people here appreciate Mises' theory of dealing with the boom/bust problem early and how this would ultimately be good for Greece (and for the EU, because the Greek debt would eventually - even if a few more years down the road - have to be dealt with instead of ignored). For the Keynesians that control the PIIGS, this would be apostasy on a large enough scale to sufficiently warn against contagion.

Either which way, the bust is coming. I think dealing with Greece harshly (not from a reality standpoint but from a Keynsian perspective) is the only way to continue to kick the can. If Greece successfully dictates its free money bailout terms, that will be the real contagion.

For example, and I don’t know the same correlation to Greece, but would the Obama Administration trade other World agents paying down our interests on the national debt if that meant it must stop borrowing and printing, today? In exchange for that .45 Trillion in debt management, we’d have to cut 1.4 trillion in spending, for a net haircut to OUR gov’t of almost 1 Trillion in spending. What Keynesian Nation would make that trade? Contagion contained.

Everything else would be cleaned up by continuing to play the confidence game: everything is AOK!

Maybe I'm rambling in my first post here. It just seems that since failure/default is already built in, the political play would be to make the best lemonade possible out of it instead of pretending it didn't happen. The players know what's going on and they are the contagion risk, not the lay public.

Sun, 06/19/2011 - 05:42 | 1382100 viator
viator's picture

"Senior sources have revealed that leading banks, including Barclays and Standard Chartered, have radically reduced the amount of unsecured lending they are prepared to make available to eurozone banks, raising the prospect of a new credit crunch for the European banking system.

Standard Chartered is understood to have withdrawn tens of billions of pounds from the eurozone inter-bank lending market in recent months and cut its overall exposure by two-thirds in the past few weeks as it has become increasingly worried about the finances of other European banks.

Barclays has also cut its exposure in recent months as senior managers have become increasingly concerned about developments among banks with large exposures to the troubled European countries Greece, Ireland, Spain, Italy and Portugal."

Spanish banks have become the main focus of market concerns with the latest European Central Bank (ECB) figures showing that Spanish banks have been forced to increase their use of ECB lending facilities and borrowed a total of €58bn (£51bn) in May, up from €44bn in April.

“We have been amazed at the ability of Spanish banks to find ways to fund themselves, but it is clear they are running out of options,” said one senior analyst at a major investment bank"




Sun, 06/19/2011 - 07:17 | 1382156 Medea
Medea's picture

This so-called "normal world" never has and never will exist, making it anything but the norm. We should stop using it as a benchmark.

Sun, 06/19/2011 - 07:34 | 1382177 mogul rider
mogul rider's picture

A derivative of a derivative which is then derivedfurther is still what it is

A piece of shit thrown against a wall.

The mathematicians always try to bake something new.

It is still the shit that it was before - it is just new shit with a different name.


The only difference this time is the shit is now exponential and non-linear. It will ruin our day regardless of which side you are on.

Someone will win the trade but the aftermath will wipe us all out.


Except for those who prepare with bazookas, Ak's, bigger gunz, gold, silver, bitchez and mo' bitchez


Sun, 06/19/2011 - 07:52 | 1382189 Alea Iacta Est
Alea Iacta Est's picture


Looks like the rats have begun to abandon the ship. Have you seen this?


Sun, 06/19/2011 - 23:13 | 1383718 XPolemic
XPolemic's picture

Those wacky and totally solvent UK banks. It's not like their debt to gdp ratio is 240% .... ha ha ... oh wait ...

Sun, 06/19/2011 - 08:06 | 1382201 Catullus
Catullus's picture

Ah, actually reading the DTCC numbers.  It's like looking up facts to support claims and whatever.  Journalism, bitchez! Haha.

I wonder if the Fed is underwriting those CDS transactions on US debt.  They've used interest rate swaps to manage interest rates in the past.  Maybe they'll underwrite US Debt CDS to encourage banks to continue to lend money to Uncle Sam even after this round of QE.

Sun, 06/19/2011 - 08:08 | 1382202 rapier
rapier's picture

"....making the key European liquidity backstopper insolvent (in practice if not in theory: after all the ECB will just print more €)"


Isn't this exactly backwards.  In theory they will be insolvent but the printing press  means that in practice it won't be.

Sun, 06/19/2011 - 09:42 | 1382287 adonisdemilo
adonisdemilo's picture

At the risk of sounding simplistic, a CDS is only an insurance against an event that could be detrimental to the purchaser of said insurance.

It seems to me that, as with all derivatives, you need at least a dozen degrees and absolutely no common sense to understand the many ways you could be ripped off by them.

If you have insurance against an event and the event occurs, you collect, period.

If the issuers of said insurance can't pay then they are insolvent, bankrupt.

If they were selling said insurance knowing that they wouldn't be able to pay then that is fraud.

Are all the entities selling CDS's frauds?

Answers consisting of at least 3 letters on a postcard please

Sun, 06/19/2011 - 16:24 | 1382953 sgt_doom
sgt_doom's picture

"At the risk of sounding simplistic, a CDS is only an insurance against an event that could be detrimental to the purchaser of said insurance."

Nonsense!  There are many, many ways to utilize CDSes to do a "bear run" against a financial institutional or sovereign wealth fund (country). 

Are we already forgetting Lehman Bros. and Bear Stearns!

Sun, 06/19/2011 - 10:00 | 1382299 EZYJET PILOT
EZYJET PILOT's picture

What gets me is how this website is all of a sudden seemingly championing one of the main instruments which led us to the 08 meltdown. Is it me or is anyone else slightly perturbed by this about face?!


Read this!

Sun, 06/19/2011 - 10:02 | 1382314 Tyler Durden
Tyler Durden's picture

That story is very misleading. And furthermore in case you missed it, as one of the commentators pointed out, the whole point of this site is to lay blame where it truly lies: in this case not with the instrument of mass destruction, but the people behind it. If you actually read the post instead of jumping to the preconceived conclusions, you will understand that the position here is that even if CDS were never concevied, AIG or any other moron with a complex of grandure would have still blown themselves up in the credit bubble.

CDS are very much a natural way to counteract the long-only bias of cash paper instruments. Good luck shorting 85% of the bonds in circulation if it wasn't for CDS. Oh but wait, yes let's ban CDS altogether so the only possible risk expression is one of long risk.


Sun, 06/19/2011 - 13:47 | 1382545 cdskiller
cdskiller's picture

This advertisement was produced and paid for by the ISDA. A Community Banking Association.

Innovation. Freedom. Security. Government backed.

People serving people, just

(Insert picture of a young couple with a baby standing in front of a house with a SOLD sign)

I can't decide if that argument is disingenuous or simply convenient. Guns don't kill people, either, and if we have gun control, only criminals will have guns, right?Absolutely, the blame lies with the people. But you can't change people. But you can take away the ability of sociopaths to buy assault rilfes.

I mean, the idea that CDS contracts are simply benign, natural, low-margin price discovery instruments is hard to take seriously. Timmay made the same argument when he was heading the Federal Reserve Bank of New York. You want to sleep with him, go ahead.  To paint everyone who disagrees with you about the useful necessity of these swaps as a mainstream idiot is simply not factual. There are many, many brilliant people with enormous integrity, intellectual rigor and experience in the markets who don't see eye-to-eye with you on this issue. Partnoy, Das, Steinherr, a host of others. Are you saying they are all idiots?

Sun, 06/19/2011 - 19:04 | 1383177 Tyler Durden
Tyler Durden's picture

They are most certainly entitled to their opinions

Sun, 06/19/2011 - 23:21 | 1383743 XPolemic
XPolemic's picture

CDS are very much a natural way to counteract the long-only bias of cash paper instruments. Good luck shorting 85% of the bonds in circulation if it wasn't for CDS.

That's the part that confuses me. Is it true that no other instrument allows you to take a short position against a bond/fixed income instrument?

Bond option, bond future option, cap, floor, swaption? Or are those markets too illiquid?

Or is it the express protection against a credit event as opposed to market price/change in spread?

Sorry to be dense.


Tue, 06/21/2011 - 06:40 | 1388276 XPolemic
XPolemic's picture

Seems like I can't get an answer to this question from anyone. Wikipedia and Google have failed me also.

I'm going to guess that bond options (and probably caps,floors and IR swaps) give you protection against changes in spread/interest rates, but are probably not exactly suited to protection against issuer default of the underlying instrument.

It also seems strange (to me) that there would be such a large market for people who think that governments who have issued sovereign debt will default. Corporate bonds I understand, mortgage backed securities obviously, but sovereign powers?

Surely the state has the power to create as much money as it wishes to pay it's debts (like the Weimar Republic to pay war reparations). Or does it? (Yes I know the currency would collapse, but the debts would be paid in notional terms).



Sun, 06/19/2011 - 10:23 | 1382339 EZYJET PILOT
EZYJET PILOT's picture

The trouble is, CDS creates the risk. As you must realise, we exist in an environment where banks are basically risk off, in the sense of being back stopped by you and I, doesn't that make you wonder about the true nature of CDS in such a landscape? By the way I fly planes, what the f@ck do I know?

Sun, 06/19/2011 - 10:35 | 1382357 disabledvet
disabledvet's picture

it's not the job of "the banks" to inform.  between the media, the CIA and all the world's "collective intelligence Agengies" i find it utterly hilarious that somehow the "powers that be" aren't "informed."  the irony of course in this so mis-named "information age" (more like the age of psycho-purience in my book) it turns out the need for free moula and the unwillingness to "pay for it" is greater than ever.  far from Greek "contagion" these are in fact "knock on" effects from let us hope good old fashioned speculators who understand that the very notion of a "United Europe" has been nothing but all talk and by "using Greece as the cue ball" they can then "knock Ireland and Portugual" and "let fall where it may."  Hence this observation as my take on the systematic dismantling of the European Union such that an order be created on some system OTHER THAN purely statist purposes.  The madness of state sponsored enterprises knows no bounds--indeed one need only look at America's banking sytem!  Of course "there's always the State of Israel" if "there was ever any doubt where the State stood on that score to begin with."  Here we stand the "victory over communism" deep in our rear-view mirror and "still we are told we need not pay for anything" provided "you vote for me in November."  Yesssss, of course "count me in!"

Sun, 06/19/2011 - 10:43 | 1382364 EZYJET PILOT
EZYJET PILOT's picture

Tyler, I know there are quite a few Tylers but Tyler will suffice, my pre-conceived ideas on CDS were formed by reading this website, hence my confusion with what seems to be a change in tack. Must have a new batch of writers on the blog or something. 

Sun, 06/19/2011 - 11:27 | 1382447 EZYJET PILOT
EZYJET PILOT's picture

Charles Hughes Smith, a regular contributor on Zerohedge, explains the CDS scam.

Sun, 06/19/2011 - 12:02 | 1382514 Tyler Durden
Tyler Durden's picture

Charles is naturally entitled to his opinion. Charles probably also never traded CDS. The truth is that for everyone who was bearish credit in 2006-2008 CDS were a blessing when putting on short credit positions, something that actually helped mitigate the collapse due to short covering into the abyss, and also a natural way to express a bearish bias. Yes, that Cassano took it to a whole new level is why he should have been thrown in jail. But people always throw the baby out with the bathwater when presenting overarching general conclusions.

And incidentally the Zero Hedge staff has not changed.

Sun, 06/19/2011 - 15:08 | 1382846 allenaki
allenaki's picture

excellent knowledge Tyler


Sun, 06/19/2011 - 16:36 | 1382976 6_7_42
6_7_42's picture

So the 1000 trillion overhang in derivatives is good for the market? Interesting POV and thanks for confirming your bread is buttered by the existence of these products. A simple thought is that maybe regulators ought to prevent bubbles rather than allow secondary "bearish sentiment" bubbles to arise? Frankly, IMHO > 66% of activity in the "markets" is parasitic. The end of fractional reserve finance of all kinds would be a great blessing. Merely consider the effect if margin stock trading were eliminated? How many professionals would have no job and therfore need to contribute to society? No fractional federal reserve bank, no fractional reserve stock market, no government borrowing. Imagine it, a better world.

Sun, 06/19/2011 - 11:38 | 1382464 Stuart
Stuart's picture

When there is counterparty default, notional value = settlement value.   This is front and center in this issue.  These 'insurance' polcies have been oversold.   Did anyone not learn anything from AIG?  This is AIG all over again, just more players. 


Sun, 06/19/2011 - 11:46 | 1382469 overthehill
overthehill's picture

TD, your very good article and all the, also, very good comments are extremely illuminating about the processes involving CDS,CDO,MBS, etc. They are certainly worth the time to absorb. However, IMHO the problem facing us all is that the entire alphabet soup of financial risk vehicles has to be eliminated completely. These financial inovations derived to be purposely complex, and therefore beyond the comprehehsion of most people both in and out of the financial organizations, are truly scams perpertrated by the worst examples of greedy people out to fleece the public. It has been well, and accurately pointed out that the MBS built on sub-prime mortgages was the Achilles heel of the entire structure of inter-related financial devices. The very idea that mortgage creating banks are allowed to sell mortgages and then blithely issue more of them is fundamentally an unsound idea that just amplifies the fractional banking concept. Until that practice is put to an end the entire pyramiding process that it leads to will just build until it collapses, as we have just seen it do. I think it would be instructive to do an article on the concept of bank practices of selling mortgages and in the process not only forming the base of an inverted financial pyramid but clouding mortgage titles in the process using that other financial aberration known as MERS.

Anyway  thank you very much for keeping this entire matter in front of of your readers.

Sun, 06/19/2011 - 12:04 | 1382532 anony
anony's picture

Assuming that Greece owes 165 billion dollars, to whom is that debt to be paid?

And furthermore if I borrow $165 billion dollars I must need it for some purpose since I'm unlikely to want to pay interest on money I don't need.

I take the $165 billion and I spend it, on bread, Ouzo, and oregano. The person selling these things to me therefore has a part of my $165 billon which he in turns spends or invests in Greek dishes to break at weddings.

And on and on it goes, my $165 billion circulating and causing bow coo amounts of economic activity, mulitplying itself like bunny rabbits.

So how did I get to a place where the $165 Billion I owe cannot be paid back?  I did nothing with that money to earn a living?  Does that mean that all $165 Billion eventually left Greece to just buy stuff and no one had to work?

Where did the $165 billion go? 

Sun, 06/19/2011 - 12:09 | 1382536 EZYJET PILOT
Sun, 06/19/2011 - 14:01 | 1382722 XPolemic
XPolemic's picture

Site down. Was it a Rick Roll?

Sun, 06/19/2011 - 12:10 | 1382539 EZYJET PILOT
Sun, 06/19/2011 - 14:31 | 1382771 PulauHantu29
PulauHantu29's picture

Talking a little bit off the subject, has anyone checked out the "Greek Online Dating Service" link to the right?

I wonder if they are really Croatians disguised as greeks?

Mon, 06/20/2011 - 00:19 | 1383902 EZYJET PILOT
EZYJET PILOT's picture

Tyler, I'll agree to disagree on CDS. I respect your opinion. Do you agree though in very basic terms that CDO's and other derivatives of that nature were instrumental in collapsing the economy last time around? I just need to know that zerohedge is still on my wavelength as regards pointing the finger of blame at financial institutions, in short are you on our side, or there's?

Mon, 06/20/2011 - 09:25 | 1384577 ZeroPower
ZeroPower's picture

Id say it was free money, greed, imprudent CEOs, careless risk management, and NINJAs.

PS - fun airline, always impressed with how takeoffs were never late, sometimes early.

Mon, 06/20/2011 - 09:28 | 1384583 Youri Carma
Youri Carma's picture
Greece poses $41 billion risk to U.S. banks, By Matt Andrejczak, SAN FRANCISCO (MarketWatch)
Mon, 06/20/2011 - 16:09 | 1386168 Ursa Major
Ursa Major's picture

Funny how everyone is jumping up on the table, beating their chests, and bellowing about the certainty of imminent default...which simply is not going to happen. Funny thing is that when Greece fails to default, there will be a lot of postings about how a) we knew all along that it wasn't gonna, and b) that some even more terrible catastrophe will befall us thanks to Greece failure to default.

Mon, 06/20/2011 - 19:53 | 1386951 XPolemic
XPolemic's picture

Technically, they already have defaulted. Except in the modern world, they call it a bailout package.

When you can't pay your debts, and someone else has to give you money to pay them, you're broke.

Tue, 06/21/2011 - 01:50 | 1388020 Ursa Major
Ursa Major's picture

from the bondholder's standpoint, at least, there is a slight difference.

Tue, 06/21/2011 - 07:01 | 1388283 XPolemic
XPolemic's picture

The bondholder's exposure has been transferred from the issuer of the bond, who is now a deadbeat, to their 'generous uncle' who is picking up the tab.

That's what is so amazing (and scandalous) about this. We already KNOW that Greeks don't pay their debts. Not now, not then, and at no time in the future.So now everyone is looking to the generous uncles to see what their plan is.

I mean really, Germans love sunny mediterranean holidays, so do Brits. 100 islands, 300 resorts, 50 water taxi services,30,000 summer staff. PROBLEM SOLVED.


Tue, 06/21/2011 - 01:55 | 1388021 Ursa Major
Ursa Major's picture


Tue, 06/21/2011 - 06:46 | 1386169 Ursa Major
Ursa Major's picture


Mon, 06/20/2011 - 16:14 | 1386171 Ursa Major
Ursa Major's picture


Do NOT follow this link or you will be banned from the site!