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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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Sun, 12/12/2010 - 14:16 | 800242 Biggus Dickus Jr.
Biggus Dickus Jr.'s picture

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

Sun, 12/12/2010 - 21:14 | 800733 jm
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!

Sun, 12/12/2010 - 23:17 | 800891 IQ 145
IQ 145's picture

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

Sun, 12/12/2010 - 14:23 | 800252 DisparityFlux
DisparityFlux's picture

The CDS Gamesters of Triskelion.

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

Sun, 12/12/2010 - 15:07 | 800311 Misean
Misean's picture

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

Sun, 12/12/2010 - 18:41 | 800556 Careless Whisper
Careless Whisper's picture

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


Mon, 12/13/2010 - 14:09 | 801991 tamboo
tamboo's picture

try again:

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

and they just increased our donations!


Sun, 12/12/2010 - 14:39 | 800273 cossack55
cossack55's picture


Cool French Word

Sun, 12/12/2010 - 21:40 | 800763 Ned Zeppelin
Ned Zeppelin's picture

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

Sun, 12/12/2010 - 14:46 | 800285 TexDenim
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.

Sun, 12/12/2010 - 15:21 | 800322 velobabe
velobabe's picture

i bet your HOTTer

Sun, 12/12/2010 - 20:23 | 800667 bingocat
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).

Sun, 12/12/2010 - 23:56 | 800943 IQ 145
IQ 145's picture

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

Sun, 12/12/2010 - 14:47 | 800286 TooBearish
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.

Sun, 12/12/2010 - 16:09 | 800356 ZeroPower
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.

Sun, 12/12/2010 - 19:53 | 800633 bingocat
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...

Sun, 12/12/2010 - 14:47 | 800287 Quixotic_Not
Quixotic_Not's picture

Goldman Sachs:

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

Sun, 12/12/2010 - 14:52 | 800291 Widowmaker
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.



Sun, 12/12/2010 - 16:32 | 800387 UGrev
UGrev's picture

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

Sun, 12/12/2010 - 17:15 | 800449 Widowmaker
Widowmaker's picture

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


Sun, 12/12/2010 - 15:02 | 800307 EscapeKey
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.

Sun, 12/12/2010 - 20:04 | 800647 ZackLo
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.

Sun, 12/12/2010 - 15:17 | 800317 inkt2002
inkt2002's picture

Whatever happened to the Chinese rate hikes?

Another ZH prediction gone wrong.

Sun, 12/12/2010 - 16:17 | 800367 inkt2002
inkt2002's picture

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

Sun, 12/12/2010 - 16:47 | 800410 Bolweevil
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.

Sun, 12/12/2010 - 17:40 | 800479 inkt2002
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



Sun, 12/12/2010 - 22:23 | 800812 Iam_Silverman
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).


Sun, 12/12/2010 - 16:05 | 800351 ZeroPower
ZeroPower's picture

RR was raised. Int rate, soon i suppose.

Sun, 12/12/2010 - 15:19 | 800321 velobabe
velobabe's picture

clearing house, bitchez†

Sun, 12/12/2010 - 15:23 | 800323 Sudden Debt
Sudden Debt's picture

Read this piece about the Silver derivative market manipulation:


Sun, 12/12/2010 - 18:38 | 800552 Spigot
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.

Sun, 12/12/2010 - 19:58 | 800639 Sudden Debt
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.

Mon, 12/13/2010 - 04:50 | 801139 EscapeKey
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.

Mon, 12/13/2010 - 12:49 | 801697 Spigot
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.

Sun, 12/12/2010 - 20:00 | 800640 bingocat
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).

Sun, 12/12/2010 - 15:31 | 800329 Atomizer
Sun, 12/12/2010 - 15:39 | 800335 curious1
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

Sun, 12/12/2010 - 15:49 | 800338 curious1
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."

Sun, 12/12/2010 - 16:02 | 800350 Bolweevil
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?

Sun, 12/12/2010 - 22:26 | 800817 Iam_Silverman
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?

Sun, 12/12/2010 - 15:50 | 800339 Bolweevil
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?

Sun, 12/12/2010 - 15:55 | 800344 Lionhead
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!

Sun, 12/12/2010 - 20:50 | 800705 kaiserhoff
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.

Sun, 12/12/2010 - 16:02 | 800348 Dragonsgrace
Dragonsgrace's picture

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

Sun, 12/12/2010 - 18:04 | 800511 A_MacLaren
A_MacLaren's picture


Did you forget the </sarcasm>?

Sun, 12/12/2010 - 22:19 | 800804 Iam_Silverman
Iam_Silverman's picture

I'm pretty sure it was implied.

Sun, 12/12/2010 - 16:23 | 800372 Hannibal
Hannibal's picture

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

Sun, 12/12/2010 - 18:11 | 800517 Lord Koos
Lord Koos's picture

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

Sun, 12/12/2010 - 19:18 | 800597 penisouraus erecti
penisouraus erecti's picture

Hope springs eternal - could be a Cubs fan

Sun, 12/12/2010 - 16:42 | 800398 OhBaldOne
OhBaldOne's picture

A Secretive Banking Elite Rules Trading in Derivatives 12 Dec 2010 On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan. The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable -- and controversial -- fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential...


But two people with direct knowledge of ICE’s [InterContinentalExchange]  committee said the bank members are: Thomas J. Benison of JPMorgan Chase & Company; James J. Hill of Morgan Stanley; Athanassios Diplas of Deutsche Bank; Paul Hamill of UBS; Paul Mitrokostas of Barclays; Andy Hubbard of Credit Suisse; Oliver Frankel of Goldman Sachs; Ali Balali of Bank of America; and Biswarup Chatterjee of Citigroup.

[Um, where are the the 'insurgents' when you 'need' them?]

Sun, 12/12/2010 - 16:43 | 800401 kaiserhoff
kaiserhoff's picture

Great summary, thanks.  It's odd that two years on, so many do not understand that this is the heart of darkness: this is why TBTF is still TBTF.  In a simple phrase "counterparty risk."  Sure, you are insured, but if some one goes under, you are an unsecured creditor of a bankrupt bank.  If one goes down, they all go down, and the band played on...

Sun, 12/12/2010 - 16:44 | 800403 OhBaldOne
OhBaldOne's picture

Previous posting courtesy of Lori Price from

Sun, 12/12/2010 - 16:58 | 800430 TraderTimm
TraderTimm's picture

So I wonder, whatever happened to this:

Or is it just D.O.A?

Sun, 12/12/2010 - 17:40 | 800480 Stuck on Zero
Stuck on Zero's picture

There are laws to handle these people and they go by the name RICO.

Sun, 12/12/2010 - 22:34 | 800829 MrSteve
MrSteve's picture

Ricco was Elliott Ness's Untouchables best Chicago trigger man. Cue Walter Winchell. We need Ricco on RICO.

Sun, 12/12/2010 - 17:46 | 800491 In Fed We Trust
In Fed We Trust's picture

Enter the bomb.

We all know that international bankers fund wars in between business cycles.

These CDS contracts allows for the bankers to collect when certain firms and cities are blown off the map by the military.

Then the US military can get paid on its CDS when it blows something up. 

The bigger the war, the bigger the CDS payouts.


Sun, 12/12/2010 - 18:37 | 800551 FranSix
FranSix's picture

I wouldn't be surprised if this was the motive behind 'controlled demolition.'  Makes sense?

Sun, 12/12/2010 - 17:53 | 800498 Big Galoot
Big Galoot's picture

The secret of life is honesty and fair dealing. If you can fake that, you've got it made.

Sun, 12/12/2010 - 22:30 | 800824 Iam_Silverman
Iam_Silverman's picture

If you write the rules (such as for the CDS exchange), then you get to say what is honest and fair.  How can you not have it made?

Sun, 12/12/2010 - 18:30 | 800532 Spigot
Spigot's picture

Manias require a money machine and an insurance scheme in order to perpetuate themselves, and typically fail due to one or the other failing to provide for the advancement of manic pricing.

Once these break down and prices fall then the cover is ripped off of the corruption that has become endemic, the masses repudiate the market and walk away from it en masse.

This particular mania still has a money machine (The Fed) and insurance scheme (Interest Rate and Credit Default Swaps), which continue to operate.

In spite of the first waves of failure and exposure of frauds there has not been enough failure of price of assets to destroy the money and insurance schemes and so people en masse do not yet repudiate the markets and walk away. Sure they are aware that there is all sorts of fraud, but they are not YET motivated to do anything but watch from the sidelines at this point.

The success of fraud in levitating the equity markets has been somewhat like a stiff drink or two getting people to relax a bit. I even hear folks where I work casually discussing restarting their retirement account contributions. Sure, they know its a rigged game but they are not en masse willing to step away from the grotesque circus...

We shall see how people deal with the inflation of necessities sucvh as food, fuel, etc.

Sun, 12/12/2010 - 19:38 | 800620 moneymutt
moneymutt's picture

And we are supposed to think they are genius capitalist when all they produce is fraud, and every cent that they take from others it pervesion of the market and parasitical

Sun, 12/12/2010 - 19:55 | 800635 DisparityFlux
DisparityFlux's picture

Two latest Bloomberg articles related to CDS,

Credit-Swap Market Shrinks 50% From 2007 Peak After `Tear-Ups,' BIS Says

Default Swaps Jump Most Among BRICs as Inflation Breaches 5%: China Credit

the first is short on detail, but provides some trend information, and the latter article brings up the notion:

“China is trying to cool things down and manage a deflation of the bubble,” ...

“If that fails then that’s how CDS gets driven up, because concern will be that the sovereign balance sheet will have to bear the costs of restructuring banks.”

Somehow, this statement seems to pale to insignificance considering the fine mess our "sovereign balance sheet" is in while the Bernanke attempts to re-inflate asset bubbles.  One would think a 5-year CDS on US treasuries could not be afforded by anyone, except maybe China.

Sun, 12/12/2010 - 23:59 | 800950 Drag Racer
Drag Racer's picture

I just see a big 'red flag' when reading a post like this. When the scam is working great, no outsider is allowed to play let alone know what the scam is. When the masses are invited to play this usually means the game is over and the hole dug is too deep to climb out of. They need to find a sucker to dump the worthless crap on...

Mon, 12/13/2010 - 06:43 | 801170 hugovanderbubble
hugovanderbubble's picture

LONG spanish CDS till 1000 bp.


Spain is in default.

Mon, 12/13/2010 - 07:35 | 801193 thepigman
thepigman's picture

So long as the banks have worthless

toxic garbage to work off (and it

looks like this will be forever) every

chair at the casino has to be rigged  to

give them a guaranteed win on ANY

new position they take. Pretty obvious

so far, ain't it?

Mon, 12/13/2010 - 08:16 | 801196 Coldfire
Coldfire's picture

We live in an age of near-universal self-deceit.

Mon, 12/13/2010 - 09:08 | 801252 shortus cynicus
shortus cynicus's picture

Max Keiser stated in report 102 that CDS are a scam. This contracts can not be payed because issuers (big banks) have no founding for this purpose. Example: imagine Ireland or California goes insolvent, how is Goldman Sachs & Co. going to pay all the outstanding debt to CDS holders ?

The whole business it mathematically inconsistent: you can insure against event targetting small number of insured items, but you can not insure against failure of all items at the same time !

If meeting an obligation is per definition impossible, so this "product" is a certain scam, fraud, full of shit! That's why it can not be regulated - how would you regulate fraud-by-design contracts ?

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