A default that isn’t a default and a sale that isn’t a sale

Bruce Krasting's picture

A default that isn’t a default and a sale that isn’t a sale

By Bruce Krasting

One of the biggest frauds of the past few years took place yesterday. The International Swaps and Derivatives Association (ISDA) confirmed that no “event of default” has occurred with the Greek debt restructuring, therefore no payouts on any outstanding Greek Credit Default Swaps (CDS) contracts are due. 

The following are just a few of the links this morning on those who disagree with the ISDA. I particularly liked Barry Ritholz’s comment, "Bullshit."



I wonder if the ISDA decision was not intended to end CDS contracts as a tool used in global finance. That certainly will be the consequence. Who in their right mind would buy an insurance policy on their sovereign bond exposure, knowing that the outcome is rigged and no payout can ever be expected?

I’ll go on record with this one. In less than one year, the bankers and political leaders in Europe will come to hate the ISDA decision. By destroying the private market for sovereign risk insurance, they have made it certain that Spain, Portugal and Italy will be locked out of the global bond market. Global investors were already shunning these countries. The ISDA decision on Greece will just make it worse for other countries that are considered potential default candidates.

There was another development yesterday that had parallels with the ISDA decision on Greece. The US Treasury sent out an email:


This is a technical discussion on Internal Revenue Service (IRS is Treasury) rule #382. This rule spells out how a company's Net Operating Losses (NOLs) are treated in the event that the company is sold to a third party. Rule 382 was introduced in 1986. The initial intent was to limit the sale of a company’s tax losses. Treasury had this to say about the importance of rule 382:

It is a longstanding principle of our tax code, which is designed to measure taxable income more accurately over time.

Rule 382 is longstanding, and it does measure income more accurately (and fairly).

There is no dispute as to what happened in 2009. A number of very large US banks went tapioca. Banks like Citi and BoA (and many others) would have had to close up shop if the government had not intervened. If the big banks were shuttered, it would have had very significant and lasting consequences. So the government implemented TARP. The government’s initial investment in the banks was in the form of preferred stock. The "Pref" was convertible to common (and later it was, for the most part, converted). Through this process the federal government became the TARP banks' controlling shareholders. To insure that the banks were doing what their new owners (the tax payers) wanted, the Treasury inserted individuals at the banks in supervisory positions.

What took place in 2009 is a classic definition of Change of Control. The active intervention by the Feds coupled with the public ownership/control of a majority of the common stock of the banks was functionally a sale.

If the transactions were treated as “sales” (which they were), rule 382 would have been triggered causing devastating consequences to the banks. The banks had hundreds of billions in losses (NOLs). The financial future of many of the TARP banks dependended on their ability to use the old losses to shelter future gains. Treasury agrees with that conclusion:

Treasury determined that guidance was necessary to clarify the scope and applicability of Section 382.


The Notices provide that Section 382 does not apply to the government’s investments—both its purchase and, within strict limitations, its subsequent sale of shares in private companies.

With that, the usual financial consequence of the change of control/sale that was precipitated by TARP were waived. This decision saved the banks. Treasury concurs:

Allowing those companies to keep their NOLs made them stronger businesses.

The US banking system and economy would look very different today if rule 382 had been applied to the change of control of the banks in 2009. Without the NOLs, the old banks had no assets. But the NOL’s were allowed to be retained; they were treated as an “asset”. This saved the banking system as we know it.

Separately, the administration is crowing about the "success" of TARP, and how little it cost:



In measuring the costs, the administration fails to include the losses that the government (aka the taxpayers) incurred as a result of the NOLs. The NOL’s are a backdoor bailout that the (now profitable) banks can use to avoid the taxes they would normally be paying.

Treasury makes an impassioned defense of its decision to allow the banks to avoid the 380 trap. I’ll let you decide if they make a convincing argument (Link).

The last sentence of the report sums up Treasury’s whole case:

The IRS Notices interpreted the law in the best interest of taxpayers.

This is the last sentence from the ISDA’s statement (Link) in defense of its decision on not calling a default on Greek debt:

In sum, we think the credit event/DC process is fair, transparent and well-tested. There’s simply no evidence to the contrary.

I think both of these statements are bullshit.



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citta vritti's picture

Great job pointing this out, Bruce, esp. about the special interpretation of the Section 382 NOL carryover rule. Thank you. Like Orwell wrote, "some animals are more equal than others." It must mean that the long term perspective of the banks is that money today, as ever, is worth more than money tomorrow even, or especially, at ZIRP plus Ctrl. Print. As the world's largest or second largest group of debtors (just guessing here), the assets they own must be (have been for some time) worth less than their obligations; is it any wonder they and their sovereign overlords (the largest or next largest group of debtors, again just guessing) favor a policy of inflation to ease their way forward through the years of debt? And deflation of the sudden kind - destruction of debt - is the all too real scare tactic used to justify the ongoing dilutive bailouts to benefit the ones in charge who screwed it up in the first place. 

DosZap's picture

citta vritti


But,but, but, they were JUST LOOKING OUT FOR THE TAXPAYERS!!!.


GeneMarchbanks's picture

'I wonder if the ISDA decision was not intended to end CDS contracts as a tool used in global finance. That certainly will be the consequence. Who in their right mind would buy an insurance policy on their sovereign bond exposure, knowing that the outcome is rigged and no payout can ever be expected?'

Those who are trapped and/or ashamed, that's who. While I'd really like to share in your world view of this situation, I can't for the simple fact that the entire ISDA ruling was never in doubt. Sure, we can call 'bullshit' but we already knew that since the entire complex is faith based. 'Law' is open to interpretation and the banking cabal is outside of it anyway.

FeralSerf's picture

CDSs are the lipstick that goes on the pig. They're promises that only appear to insure the principal to make the investor feel good and allows the advisor to have someone to point fingers at (+enable one hellava casino game). They only work when there's NOT a big default.

It's like buying an insurance policy to protect one from large asteroid impacts.

Gold Dog's picture

Feral, Please define "large"....we aint payin!

Aunty Christ's picture

Agree with TD's comment above. Given the constituents on the ISDA board ( JPM,GS, Citadel et al) if they don't rule the greek debt restructuring as a credit event, it amounts to a financial Jonestown.

apberusdisvet's picture

Poof:  foreclosure law

Poof:  contract law

Poof:  bankruptcy law

Poof:  accounting standards

If it walks, squawks and talks like a duck;

it's fascism or financial anarchy, or both

DosZap's picture



 it's fascism or financial anarchy, or both

By George, I think he's got it!.

disabledvet's picture

where's Mayhem Corner at?

Joebloinvestor's picture

Kind of like standing in the rain and denying it's wet.

That will kill umbrella sales.

Sutton's picture

Jamie doesn't feel like returning MFG's loot-He gets to keep it.

Jamie doesn't want to pay out CDS'on Greece-ISDA rules in biggest derivatives dealer's favor.

On it goes

JohnKozac's picture

Certainty in the Law was a major strength in Western countries. I guess that just went out the window.



Translational Lift's picture

Went out the window with:


AIG>>>GS bailout

Auto bailout

Widowmaker's picture

Actually it was crucified by incorporation -- which completely undermines all law there is.  Where else do you get TBTF and Gov't Inc?

Zero accountability = zero enforcement = zero accountability =...


evolutionx's picture

Mises is absolutely correct: “There is no means of avoiding a final collapse of a boom brought about by credit expansion”. Whatever politicians, bankers, economists or others experts say, there is no solution to this crisis. We have reached the end of the road and are now staring into the abyss.

The credit manufacturing system that started in 1913 when the Fed was founded, began its terminal phase in 1971 when Nixon abolished gold backing of the dollar. It has been clear to us for at least 20 years that the outcome was inevitable. It was never a question of “if” but only “when” it would happen.


Benjamin Glutton's picture

mises had not contemplated digital money, trading and coordinated central banking by way of a single dominant currency backed by overwhelming military force when offering his thesis,imo.


truly unfathomable circumstances and make no mistake they will slaughter to maintain this abomination.


“There is no means of avoiding a final collapse of a boom brought about by credit expansion”.

StychoKiller's picture

I'm looking forward to the day when all the SuperComputers keeping track of all the balances overflow 64-bit registers, then start trying to compute amounts using multiple integer precision and refuse to respond to any more commands -- Ctrl-Alt-Del will be the only way out of such a conundrum...

WmMcK's picture

TPTB will just widen the bus.
Welcome to 128-bit registers, bitchez.
Corollary to Moore's law; only problem is:
expectations double every 17 months.
This may end in kernel panic instead of just a reboot.

engineertheeconomy's picture

maybe that's what the Aztecs saw in Dec 2012

knightowl77's picture

It was the Mayans, but yes TEOTWAKI...

TrulyStupid's picture

Jim Sinclair has identified this non - default declaration as the failed last chance to stop "QE to infinity"


A pattern of action has been set in place now which takes QE, the gift from Lehman’s economic clutch event, to QE to infinity, the direct result of the Greek economic clutch event that was declared via the International Swaps and Derivative Association. These Gods of Mammon declared 70% of the Greek sovereign debt to be valueless without guilt, sin or consequences.

Jim Sinclair ... read more at http://www.jsmineset.com/

Tyler Durden's picture

Our point is that for all intents and purposes yesterday's ISDA determination, based on the query in question, was not a CDS trigger as CAC had not yet been activated. It will be a different story entirely when in ten days or so ISDA receives another comparable question, and then finds no CDS trigger had happened. That would truly be a grenade in the CDS market. Thing is ISDA knows this, and they will not allow the CDS market to implode in a fashion that leaves the only open hedging option for Sovs to be selling. Said otherwise, yesterday's event was largely a non-event.

Jefferson's picture

They want to be able to blame the private sector not the public sector for triggering the credit event. But the damage to the sovereign debt market has already been done because the ECB unilaterally taking a priority creditor position has now been deemed by the ISDA not to be a credit event. The fact that CDS prices for Greeb debt have risen further in the aftermath of this decision by the ISDA validates this hypothesis.

eddiebe's picture

I respectfully disagree. These people will look you right in the eye and tell you that black is white, and back it up with the full might of the strongest military force in the world if need be, but we're a long way from that. For some reason beyond me they and their ilk ( The great Bernank comes to mind ) are still believed like Moses carrying his stone tablets down from the mountain, and worshipped like god himself.  But we'll see soon enough.

falun bong's picture

A CDS collapse would seem to say rates will rise as investors demand more yield since their principal is "less" protected. That's the conventional view. These days though who knows. Chasing yield seems like yesterday's game, today just seems to be Donkey Kong, avoiding all the insolvency barrels tossed at you. Approaching financial singularity, where there is only one creditor left standing...then poof?

TrulyStupid's picture

CDSs are designed never to function. If there is a large (sovereign) default like Greece that triggers them, the whole system collapses.

They are now revealed to be completely worthless to mitigate risk. Italy, Spain, Portugal etc. will now have a very tough time selling their new debt . They will have to rely on pure QE to bridge their fiscal gaps.

Mutatto's picture

Greece will be a small event that will cost only a few 10's of billions in net default payouts.  This will be a small price to pay to preserve the CDS industry in other, much larger markets.

The question is, will there be some counter parties that are unable to pay?  I believe the goal for the last 4 months, beginning with the fed currency swap deal, was to stuff the entire system with liquidity, to prepare for March 20.

The recent post on the rise of the Greek CDS market indicates there is still value in them, and the intentions for the hedge funds to use these to squeeze blood from the sovereign turnip.

my 2 cents


Phil's picture


Tyler is correct

If declared a non event after the CAC's have been triggered, I believe then you will see the CDS mkt explode for high risk Sovs

I also believe they will not let the CDS market explode  ----- Greece is small potatoes and there is too much money to be made by the Big 5 controlling this market.  For sure some banks will tank if a credit event is declared.

CompassionateFascist's picture

About two weeks ago, Ann "nuke the ragheads from orbit"  Barnhardt opined that the CDS's will NEVER pay. Just another fraudulent derivative. Think she'll be proved right on this one.

Mercury's picture

Readers: this ZH walk-through from last week remains the best way to orient oneself as to where we are in all this:


And this isn't a bad primer on the how/why of the auction process that follows a credit event:


Yen Cross's picture

You're right on Tyler. At least the' Mark to Market' , valuations, find some sort of reality!

Jackfish's picture

Because the policy clearly states that no claim by you will ever be paid.


Monty Python 


Silver Dreamer's picture
"The IRS Notices interpreted the law in the best interest of taxpayers."  Damn, that's funny.  
The Alarmist's picture

Funny how that rarely happens when it is the IRS vs. an average citizen.

Zero Govt's picture

It's Official: the IRS is giving everyone a free from tax holiday, signed off by Turbo Tim too

Stop Paying Your Taxes (everyone else is)

Tijuana Donkey Show's picture

By my logic, the best interest of taxpayers is not to pay taxes then. Love it!

Translational Lift's picture

Comforting to know that the IRS is now protecting "the best interest of taxpayers".

Sarc off..........

daily bread's picture

Hey, these banks are "taxpayers" (in the sense that they have to file tax returns).  So the quoted sentence is entirely true -- so long as you understand which set of taxpayers is referenced.

Wm the Shrubber's picture

The rabbit hole has no bottom.

Ahmeexnal's picture

The rabbit's hole smells of bung.

Popo's picture

Actually, at the bottom of the rabbit hole are all the angry counterparties to the CDS who just lost their shirts.

Next to them is a long ladder to the surface, marked: "Lawsuits".

jeff montanye's picture

however many of the rungs of the ladder are cut nearly through and festooned with tiny labels reading "mf global bankruptcy trustees" and "fraudclosure cramdown settlement" and "look forward not backward" and "how many millions did you contribute to my campaign?".