Secret Banking Derivative Cabal Redux, And Why HFT In CDS Has So Far Been A Failure

Tyler Durden's picture

Today, in a 3,500 word oeuvre, the NYT's Louise Story has done an expose on some of the key development in the CDS market. For those who may not have the patience of reading the whole thing, we provide an abridged summary...

  • The most profitable product for banks currently are derivatives (and CDS in particular)
  • As a result, the derivatives trading cabal wants to contain its members to as few as possible, and to preserve the status quo indefinitely
  • Margins on CDS can be anything as there is no central clearing or pricing mechanism; buyers and sellers rely on the broker to present an honest market
  • The trading desk spread profit on a CDS contract is 0.1% of notional ($25,000 of $25,000,000)
  • Spreads can be as wide as the banking cartel (Goldman, as most other banks just price at Goldman levels) deems them to be
  • Banks do not want to trade CDS on exchanges as that would kill margins
  • Citadel tried to make CDS trading into a HFT operation. It failed (for now)
  • Markit is a dominant industry-controlled player, and prevents transparency (and thus keeps margins high) in the market by not allowing broad dissemination of CDS pricing
  • Regulation is powerless to break the cabal's control

That pretty much covers it.

Of course, to anyone who has read Zero Hedge over the past two years none of this is a surprise. We have long claimed that:

  • Derivatives trading is and continues to be the most profitable product line for the banking cabal, but for Goldman Sachs particularly, whose FICC group would be a pale image of itself if it could not dominate CDS trading (link)
  • Goldman is a virtual monopoly in client-facing synthetic trading. Furthermore, it is a pure monopoly in cap arb situations that require the combination of cash and synthetic trades, courtesy of the elimination of the Bear fixed income trading unit (the bulk of which ended up going to Goldman) and the destruction of Lehman Brothers. And as virtually everything is now a pair trade in the basis realm of some sort, Goldman likely pockets, directly and indirectly, a few nickels of every single corporate spread trade in the world
  • Due to pricing opacity, it is not unheard of, and in fact happens quite often, that due to wide entry spreads, both sides of a given CDS trade can claim a profit at the same time, especially with banking facilitiation that "validated" End Of Day/Week/Month pricing tables. This leads LPs to believe that their fund investment is in much better shape than in reality, leading to a Madoff type event one day when reality catches up.
  • Markit, among others, has been alleged to provide above market pricing in the past (link). It will likely recur in the future, or as long as there is no transparent trading market for derivatives.
  • Donk is a joke? Really? Next up someone will tell us that the first US and European stress test were a lie...

In other words - a lot of recycling. One useful observation: contrary to claims to the contrary, High Frequency Trading in CDS is so far completely and totally DOA: Citadel's walking away with its tail between its legs proves it. To achieve that one needs a clearing market. And once HFT gets involved, margins plunge, and volume needs to make up for the margin shortfall. This means the market will need to be opened up to the general public. Zero Hedge firmly believes this will be the case... eventually. When that happens, CDS contract notionals will plunge from a minimum $1MM contract (and really $5MM) currently, down to $1K increments, and margin requirements will be impacted appropriately. Banks will be forced to open the CDS market to the greater retail fools. For that to happen, equities as an asset class will have to collapse, and the general public will want to move its trading higher in the capital structure. Which is why we are stunned that the blogosphere has not seen a broader penetration of CDS-focused sites (in addition to Zero Hedge): after all, when the enchantment with equities is over following the next major crash (and it is already well on its way followin 31 weeks of outflows), this will be the "next big thing", and the first entrant will have a tremendous advantage...

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Biggus Dickus Jr.'s picture

Insurance has always been a rip off in unregulated markets.  Best to stay away.

jm's picture

The last thing I want to see is SEC-type porn freaks getting more spheres of influence.

What is needed is transparency.

Try not to think about this too much:  IRS for ETFs... REITs... anybody that wants to hit the bid!

IQ 145's picture

 for the poster; thank you; a wonderfully informative article.

DisparityFlux's picture

The CDS Gamesters of Triskelion.

We are now taking bets on who believes they are holding money.

Misean's picture

I bet 50,000 Quatloos that none of them are and another 50,000 they all believe they are.

Careless Whisper's picture

it is wrong, wrong, wrong, to read about the family without playing the appropriate music.


tamboo's picture

try again:

look at what all that free ussa taxpayer money can buy,

and they just increased our donations!


cossack55's picture


Cool French Word

Ned Zeppelin's picture

Who junked this guy? Someone with an even cooler French word? Like what? 

TexDenim's picture

Louise Story is probably one of the hottest financial reporters in the country, and this story is worth reading in full, though the Cliff's Notes version provided above is excellent.

Story has two degrees from Yale -- undergrad in American Studies in 2003 and an MBA from the School of Management in 2006. I'm guessing that the NYT piece is the heart of a book she is writing, which will be well worth reading.

bingocat's picture

Louise Story's articles on finance have been largely anecdotal. Her stories, like most others, show little understanding of the actual transaction taking place. There is a guy who trades a small lot on a heating oil contract, doesn't appear to put his business out for competition, does not appear to do any research on what he is actually buying, and suspects that he is paying more than he needs to?

My local hardware store charges me 25cts for a screw when I need to buy just one. I think that screw only cost them 1ct. They are marking it up 25 times, ripping me off. I could take my business to another store where they only charge me 20cts, but everywhere I go it costs me a lot more than 1ct to buy my one screw. There must be a secretive hardware store cabal. Why doesn't she do research on this? Or on the movie ticket pricing cabal? Or the secretive decision-making around MLB which makes it difficult for me to start up my own team and join the league?

Her October article on securities lending was about as misleading as misleading can be. It lays exactly zero blame for financial losses on greedy people trying to make money by taking risk. All of the blame for investors' losses in a bond fund are on the bond fund manager. While the manager of the funds may have been less than stellar in his decisions, and the person taking the risk may not have fully understood the risks, it does not mean that the person who allocates his firm's customer's capital to someone else so that they can invest it and produce a return is blameless when the investment does not turn out exactly as expected on a mark-to-market basis.

If her book is anything like this article on the cabal, that article on securities lending, the one on "information", and the one on "price-setting", it will be highly disappointing. But I guess that one should not let little things like facts get in the way of a good story (certainly no pun intended).

IQ 145's picture

 It's an excellent article, very well written. Heaven only knows why people "junked" you for providing a biographical background.

TooBearish's picture

Interesting how the top 5 derivative players, by definition a zero sum game all claim massive profits from said ops, as notionals outstanding continue to grow skyward even in the face of stagnant end user notionals.  Rampant accounting cherry picking and wacky amortization contribute to the profit success story for derivatives.

ZeroPower's picture

You touch on a key point, the zero sum game.

The only caveat is, who holds more notional than the other - or more specifically - what party will have less of its notional be cancelled out if/when a major collapse occurs.

I laugh when i see numbers suggesting gross CDSs to be in the 100s of Trillions of $... hey, how about we inspect the net for a second and only then make a reasonable argument. Do you ever argue about Allianz and how, if every single one of their clients had an accident at the very same time, that they'd be fucked? No, you don't.

bingocat's picture

Thank you.

The same argument comes up when people talk about fractional reserve banking - after all, if all banking debtors suddenly decided not to pay their debts, then the depositors would be screwed - funny thing is the same happens under full-reserve banking...

Quixotic_Not's picture

Goldman Sachs:

Stacking gaming theory one fraud on top of another since 1869.

Widowmaker's picture

In other words, a government-sponsored/endorsed monopoly of fraud and collusion at the expense of free markets and justice, paid for by citizen blood in fake wars.



UGrev's picture

how 'bout we give them a push.. and we put it on youtube. 

Widowmaker's picture

No thanks, I prefer to pull the rug and enforce the laws on racketeering and do a little trust-busting. 


EscapeKey's picture

Great, I want to buy CDS "insurance" on my local small-but-market-registered-business. I have a feeling an "accident" is heading its way. (*)

The lunatics are running the asylum.


(*) No, I'm not actually going to do this.

ZackLo's picture

Can majority stake holders in a company hold CDS? Lol, if they introduce that market to retail everyone will want to blow themselves up and take all their investors money.............crap businesses will start paying people to riot and break their shit.

inkt2002's picture

Whatever happened to the Chinese rate hikes?

Another ZH prediction gone wrong.

inkt2002's picture

they are not raising rates this weekend.  ZH is off to another rumor never coming to frution.

Bolweevil's picture

Guilty I say, guilty! Still better than MSM.  Now go back and count how many "rumors" ZH has promoted that came to fruition and get back to me stat.

inkt2002's picture

My database shows the following

Since May 2007

Predictions Made= 268

Predictions Correct 39

Chance of being correct- 14.5%

Correlation of correct calls to

Bear Markets :.82



Iam_Silverman's picture

The butterfly effect?  Or maybe Heisenberg's Uncertainty Principle?

If they know that we know, then they'll change their game plan?

Even us paranoid-delusive types know we are targeted for extinction (eventually).


ZeroPower's picture

RR was raised. Int rate, soon i suppose.

velobabe's picture

clearing house, bitchez†

Sudden Debt's picture

Read this piece about the Silver derivative market manipulation:


Spigot's picture

I have seen this mentioned elsewhere and can only note that there is no relationbship between derivatives activity and the underlying assets themselves, other than the amount of the transaction in synthetic instruments far outweighs the transactions in the assets themselves. I do see this as a means of supressing activity in the underlying assets, and hence is price supressive by nature. However to attempt to argue some ratio based on gross notional derivatives amounts is pretty lalaland.

Sudden Debt's picture

Before you press the reply button, you should actually read the articles.

If you would have done so, you wouldn't be making such stupid remarks.

If ZH is good, Marketoracle is the best.

You just try to show me 1 site that shows what they have now published and I'll eat my hat.

Otherwise, you're just some lalaland hobit who only jumps to the comments because he doesn't understand what is actually written.

EscapeKey's picture

ZH makes me want to debate issues, marketoracle makes me want to shoot myself in the face to get it all over with. There is no chance MO > ZH.

ZH is THE best finance website on the web.

Spigot's picture

Your avatar seems to suit you. I've noticed that you've become pretty abusive lately. Nothing in your reply adds to the discussion.

Possibly if you visit a Electrolysist you can get the wild hair that is up your ass removed.

bingocat's picture

I agree with the last sentence but the rest is suspect.

In what way is a higher trading volume/notional for synthetics price-suppressing for the underlying? Or the derivative? If CDS are a zero-sum game then there is no net effect on price. If they are not because there are net non-hedgers out there, other things equal it would push prices in the direction of the non-hedger's bet. If most bets are to insure credit risk, then the underlying price should fall (buying insurance is selling delta). If most bets are speculative ownership (like most main stream media seem to believe), then it is price-boosting (and certainly noone would ever think that the market price for any given credit risk got too high at any point in the last several years).

curious1's picture

CFTC meeting with SEC and Golman on eligibility for clearing membership:


Membership criteria and prerequisites:
— Adequate resources and operational capabilities
— Willingness and ability to make markets in diverse set of products, including providing daily pricing
— Sufficient capital, trading expertise and formal commitment to participate in large scale liquidation

curious1's picture

There is something with goldmanites... god's work, christian perspective on wall street..

Here is one from Dir(c)k  Prius...

The students will hear from one of Goldman's best on transaction strategies and perhaps learn something even more important as Pruis gives a talk on "A Christian Perspective on Wall Street."

Bolweevil's picture

You're supposed to start those types of comments with, "Completely OT, but..." Kinda cherry picking aren't you? Your reference is from July 2000.  Exactly what is your point?  When 76% (wiki-p) of a population considers themselves Christian, don't you think there may be a couple of them working at GS?

Iam_Silverman's picture

"When 76% (wiki-p) of a population considers themselves Christian, don't you think there may be a couple of them working at GS?"

Hmmm, by that reasoning, shouldn't I also expect to see more Christians next time I am at Synagogue?

Bolweevil's picture

"we are stunned that the blogosphere has not seen a broader penetration of CDS-focused sites"

That alone has to be worth $100 a pop from Uncle (bloggerz are our frendz) Sugar?

Lionhead's picture

"This means the market will need to be opened up to the general public. Zero Hedge firmly believes this will be the case... eventually. When that happens, CDS contract notionals will plunge from a minimum $1MM contract (and really $5MM) currently, down to $1K increments, and margin requirements will be impacted appropriately. Banks will be forced to open the CDS market to the greater retail fools."

Yes, yes, where have we seen this scam before? How about 100 years ago with the "bucket shops" in New York. Anyone that trades this scam can never be assured of the pricing, the time of the pricing, the spreads, & oh, of course the margin requirements will be high to force losses on anyone stupid enough to trade in this "security." With high margins the weak hands will be fleeced by the thousands.

What does this tell us? DESPARATION by the banks. Their traditional lines of business are crumbling in the era of deleveraging, so what better way to lever up the third rate suckers that would trade this than by using 20 to 100 percent margins?

The international banking cartel's latest profit center. Anyone that would feel inclined to jump on this lead balloon, do yourself some research on bucket shops before you go all in. Good Grief!

kaiserhoff's picture

Quite so.  Same thing happened with stock options when they were first listed on the CBOE in the seventies.  Exchanges solve many problems, not least among them, the whole nonsense of too big to fail.

Dragonsgrace's picture

I am just shocked that the banksters could be this greedy. 

A_MacLaren's picture


Did you forget the </sarcasm>?

Iam_Silverman's picture

I'm pretty sure it was implied.

Hannibal's picture

Not to worry, Goldman and their criminal brethren will implode beneath their own "success".!

Lord Koos's picture

If/when they implode, the people at the top will still be set for life with huge personal fortunes.

penisouraus erecti's picture

Hope springs eternal - could be a Cubs fan