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Greek CDS and the New House Rules: Get Over It

rcwhalen's picture




 

"Derivatives shift wealth opportunistically. The theory behind them is to stabilize risk in volatile markets by providing a means to rectify a portion of the losses incurred in less liquid activities. However, every transaction produces a winner and a loser. In other words, 50% of market activity results in a realized loss to one party. Thus derivatives enable smarter firms with deeper talent pools to exploit lesser players. Herein lies the flaw for the financial industry. While volatility is stabilized for a few, the net effect on the system is that the losses are merely passed to the dumbest player at the table."

"Complex Structured Assets: Feds Propose New House Rules"
The Institutional Risk Analyst
May 24, 2004

I decided not to say much about credit default swaps or CDS over the last little while.  The reason was that the "reforms" in Dodd-Frank seems to have disturbed the collusive equilibrium between the exchanges and the large dealer banks enough for the former to finally go after the lunch of the latter. This had to happen.  Now the fact of MF Global seems to have reminded all in Chicago who is the real enemy.

The large banks led by JPM are effective acting as mini-exchanges for CDS, but with paltry disclosure and transparency and often equally poor risk management.  There is no collective oversight of exposure by the dealers in the fantasy world of OTC CDS, only opaque bilateral relationships that allow counterparties to create and hide risk from other dealers as well as regulators. 

This deliberate dysfunction in the government oversight of OTC dealers is the legacy of Gerry Corrigan, who shut down dealer surveillance at the FRBNY in 1993 before leaving in a swirl of personal scandal to join his clients at Goldman Sachs. Later Corrigan spawned the "Counterparty Risk Management Group" so that the large dealer banks could continue to obfuscate on and delay any true reform of the OTC derivative ghetto. Today, the only people in the market with a partial view are at DTCC, but even this dataset is incomplete and, by design, inconsistent in terms of the data structure.   

The Greek situation, however, has focused everyone on the basic unfairness of the OTC market model.  A private group called ISDA, which is dominated by the big banks, is the supposed standards setting body for a marketplace measured in the trillions of dollars.  This body has no set rules for judging when a default occurs, but instead uses a set of guidelines to direct a case-by-case assessment of default events.

Because of the changes in the ISDA rules post-Delphi that allow for cash settlement of CDS and other OTC derivatives, it is possible to create exposures that are orders of magnitudes larger than the cash basis -- if there is a cash basis for the contract.  The ratio of open positions to actual debt in the Delphi default was about 40:1.  In those days, holders of CDS had to deliver the underlying debt to get paid on the insurance.  In the case of today's CDS, there is no effective limit to the ability of counterparties to create long or short exposures in most corporate or soveriegn names.

The first question to ask is whether it is reasonable for market participants to be surprised by the decision taken by ISDA saying that the Greek restructuring is not a default event.  Given that this market is run by and for the dealer banks, why should any of the merry gamesters trading these cash settlement derivatives be surprised?  My friend Barry Ritholtz, for example, expressed the general sentiment -- "bullshit" -- in a fine post yesterday.  Bruce Krasting captured same in a review of the more notable yowling over the Greek CDS decision by ISDA: <http://www.zerohedge.com/contributed/2012-09-02/default-isn%E2%80%99t-de...

But why are we all surprised? 

The second, more basic question is whether it is reasonable for market participants to be surprised by the Greek outcome given the political stakes.  A greek default will probably push some of the other EU perifery states into default as well.  We already saw the EU suspend short-selling on the banks in the Eurozone.  This is just the latest step by Angela Merkel to pull up the drawbridge on Fortress Germania.

But the third and most important issue involving CDS generally is why anybody with their head screwed on tight would be surprised to see the house changing the rules on CDS in the middle of the proverbial game.  Just as casinos can now change the look, feel and odds of most slot machines on the fly and in real time via the Internet, the dealers in the world of CDS are constantly changing the contractual template, legal rules and custodian arrangement to give the house maximum advantage. 

Again in this regard, re-read the ZH post from last week on MF Global, "Where's the Cash."  <http://www.zerohedge.com/contributed/mf-global-wheres-cash-part-ii>

And what is the lesson from MF Global?  That the lawyers and lobbyists for the large banks have rigged the legal game in favor of the OTC markets and the large dealers to allow them to steal customer funds in individual accounts from a broker-dealer with impunity.  The age of financial repression turns investors into chattel.  Why are market participants so surprised that the large bank lackeys at ISDA are now enabling the banks to welch on these supposed credit default insurance "contracts?"

Some of you may recall that Tim Geithner and the Wall Street CEOs made a great fuss over the sanctity of OTC derivatives contracts during the failure of Lehman Brothers, Bear, Stearns and American International Group.  At the time of these failures, we were told that a restructuring was "impossible" because of the potential for systemic contagion if a market resolution occurred. Today, however, Tim Geithner and his clients in the large Wall Street banks prey upon investors like the creatures in the film Jurassic Park.

So please do be angry at the developments with respect to MF Global and Greece, but please do not tell me that you are surprised by any of this. The cash settlement world of OTC derivatives is not investing, but gaming.  And the House sets the rules. 

 

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Sat, 03/03/2012 - 16:21 | 2220111 TrulyStupid
TrulyStupid's picture

The question is how far back on the chain of causality to you wish to go. We can go back to the Bush adminstration's dual decision to increase fiscal malinvestment (wars, porkbarrel supply side stimulus) at the same time reducing tax revenues.

CDS and derivatives are just another layer of leverage made possible by monetary inflation and FED Reserve central planning through the manipulation of interest rates and money supply.

Politically motivated, supply side stimulus had the government and later the supply side itself picking winners and losers, resulting in huge and growing economic dislocations and volatility. We can go back to Reagan, Greenspan and the implementation of  supply side economics (cnetral planning) as the root cause or even further back to the cessation of the gold standard or the creation of the Federal reserve.

Sat, 03/03/2012 - 19:14 | 2220447 Centurion9.41
Centurion9.41's picture

@TrulyStupid,

Yes, how far one tries to follow a chain of causality is relevant to the validity of the endeavor. 

Regardless, your points belie political blindness and ignorance of mathematics. Try going back and running the numbers with all the political promises of heath care and retirement removed.  No man has a right to enslave another man in debt to pay for the results of his life style choices.

Sat, 03/03/2012 - 15:41 | 2220031 Atlantis Consigliore
Atlantis Consigliore's picture

http://youtu.be/Q-lMZwRpOA4

 

to Serve the Customers,   ITS A COOKBOOK....

Sat, 03/03/2012 - 15:34 | 2220016 fiddy pence haf...
fiddy pence haff pound's picture

I wonder if game theory works in the shadow banking sector.

I'm not saying that we can foresee a black swan or what the bankster

cartel will do after any one event, but we can only speculate

on the effect of events, inform and/or scare the MSM,

and hope that the banking thing crashes in on itself.

Otherwise, we're just a bunch of bitchy by-standers with a healthy

dose of black humour.

I do see that the banksters are determined to:

-stamp down on PM prices

-keep the fiat sharade going.

-continue to destroy rights, pensions, and other public stuff we paid for and need.

 

p.s. here's a thought:

what if the banksters are stealing European gold because they're afraid that China

will have a gold-backed currency in the medium term, or sooner? discuss.

Sat, 03/03/2012 - 14:54 | 2219927 cdskiller
cdskiller's picture

I'm sorry, but idiots who bought credit default swaps against default of sovereign debt from banks because TIM GEITHNER said OTC derivatives contracts were sacred deserves to lose everything they have.

OTC derivatives have caused one major economic collapse after another for the past 20 years. You want to play in that game and then crybaby to me about fairness, or the House changing the rules mid-game? You gonna go naked short on somebody else's debt and throw a tantrum? I'm not defending anybody, here, except the people who lost because of the derivatives-related crises of the recent past: Argentina, Asia, Russia, Mexico, LTCM, Barings, Metallgesellschaft, Orange County, Greece, the U.S., Ireland, Iceland, Spain, Italy, etc, etc, etc.

Sat, 03/03/2012 - 15:17 | 2219976 masterinchancery
masterinchancery's picture

This whole column is nothing but excuse making for a bunch of lawless criminals--telling us to "get over it" is trivializing the problem.

Sat, 03/03/2012 - 17:05 | 2220207 kaiserhoff
kaiserhoff's picture

Yes.  The laws are still on the books.  The question is when someone will grow a pair and start the public hangings.

Sat, 03/03/2012 - 14:33 | 2219880 Gromit
Gromit's picture

Of course it's gaming, always was.

A CDS contract may be legal but is unenforceable in a court of law not dominated by WallStreet IMHO.

Sat, 03/03/2012 - 17:48 | 2220306 Buck Johnson
Buck Johnson's picture

You're exactly right, its almost unenforceable if Wallstreet is the prosecutor and the judge of the court.  But what this does is make it impossible for CDS's to be bought around the world.  The funny thing is that the banks and financial institutions that are middle ground big and individuals who invest in them are getting preyed upon know and they don't like it.

Sat, 03/03/2012 - 14:24 | 2219863 davhay
davhay's picture

FUCKING BITCHES!!!!!!!!!!!!

Sat, 03/03/2012 - 14:15 | 2219835 JustACitizen
JustACitizen's picture

The Sanctity of Contracts!!!!!! ROFLMAO!!!!!!!!! Gubbermint...law...ROFLMAO - stop - it hurts!

Here's a better question - what is the point? If you want to take risk - take risk. If you do not - then don't. Oh, but I only wanted to take a little risk (but I wanted a huge upside)...

I do not think we will see rational markets and marketplaces until there is a freakin' HUGE crash. A once in a lifetime event...that will have to be repeated in 90 years  -  again.

 

Sat, 03/03/2012 - 13:54 | 2219788 onlooker
onlooker's picture

Centurion below need carefully reading. Maybe the best short look I have seen. Hope he stays and posts more

Sat, 03/03/2012 - 13:10 | 2219723 TahoeBilly2012
TahoeBilly2012's picture

I feel like I have eaten way too much cotton candy, pink popcorn, drank a few rootbeer floats and rode the ferris wheel 10 times around without getting off...and had the flu while doing it.

Sat, 03/03/2012 - 12:51 | 2219689 Eric L. Prentis
Eric L. Prentis's picture

Al Capone has is right. Explaining why he bet on the horses but not on Wall Street:

 

“It’s a racket. Those stock market guys are crooked.”

 


It takes one to know one.

Sat, 03/03/2012 - 12:41 | 2219669 Centurion9.41
Centurion9.41's picture

Great piece.  True on many levels.  However, the key cabal that created and allowed the source of 90% of the problems to exist is, contrary to what some folks like Barry Ritholtz claim, the politicians and regulators.  Not the bankster criminals.  Notice, I am saying the banking industry is filled with those whose business ethics most American's would call immoral/criminal. 

The piece ties in a great example of the myopia created by the media and blogs that suppress dissenting opinion, e.g. TheBigPicture.   A myopic focal point is Las Vegas.  A place where it is universally acknowledged organized crime behavior is common; e.g. from the piece "Just as casinos can now change the look, feel and odds of most slot machines on the fly and in real time via the Internet, the dealers in the world of CDS are constantly changing the contractual template, legal rules and custodian arrangement to give the house maximum advantage."

I come from an military aviation background, and was a trained mishap investigator.  There's a philosophy in mishap investigation that looks at the events up to the mishap as a "chain of events", and just like in today's popular Six Sigma {which is nothing more than institutionalized common sense and basic applied first year BS mathematics} the philosophy looks for those things in the chain of events that could have been changed and thereby kept the mishap from occurring.    Military aviation, combat operations excluded, is far far more safe than Hollywood portrays.  And the philosophy of "chain of events" is central to why the mishap rates came down from the high levels of the 1940s-1970s; along with engineering advancements.

CDS's are not bad instruments, they are no different than any other tool or weapon.

But just like a military jet leverages a battle space, CDS's do the same to the financial battle space.

THE single most significant event in the chain of events that contributed to the financial crisis unfolding in the way it has and continues is the NON-regulation of CDS's via captial reserve requirements - aka they were not "treated" like insurance products.

THE gross distortion and lie in analogizing CDS's as "taking out a fire insurance policy against your neighbor's house bringing down" is in the failure of those who say such things to point the finger at the one's who are given the public trust to ensure such products are not created and abused.  These are the politicians and regulators.  But these two groups literally sold out the American people to the bankers.  Literally.

IF the ability to write CDS policies were held to the same standards and regulations as insurance underwriters, the world not be facing the financial crisis it is today, period.

Now those of you who want to buy the BS of the regulators and politicians who say "well we didnt have the legal authority or charter to regulate those products".... REALLY?  How often do we witness regulators and politicians make power reaches and grabs?  How many times?  And you're going to buy that line of BS?

Without the unregulated, non-capitalized underwriting of the CDS's, the "web of cross liabilities" would not have become so complex nor would the gross exposure been able to have grown to be systemically dangerous.

That folks like Barry Ritholtz de facto defend the politicians by denying their role in not focusing on this fact, and by denying the role of CRA/politicians - which greatly expanded the single most leveraged product available to the public in the history of the world, IS part of the Big Lie that continues.

It's really not that complicated.  All the other talk about bad bankers like the little prick GS publicly threw under the bus are the crumbs of the Bread & Circus of what some call the New World Order Empire.

That's why the current legislation, Dodd-Frank, and the Volker Rule discussions are meaningless - save their ability to tie the hands of the US financial system.

The US is filled with good bankers.  All across the US there are good bankers in Credit Unions, small banks, etc.

It's time the financial blogosphere got over it's myopia and began to focus, like a time and target coordinate strike by the US military, on those events in the chain of events that are the real source of the problem, and the real issues that need to be fixed.

As my brother Maximus, a man of a real fight club, said "strength and honor"; for without these two things, this becomes tomorrow, and tomorrow and tomorrow.......   

Centurion,

Strength and Honor

Sat, 03/03/2012 - 15:04 | 2219949 hairball48
hairball48's picture

Well said

Sat, 03/03/2012 - 15:01 | 2219937 disabledvet
disabledvet's picture

Strength and Honor indeed. I agree with this 100 percent. I use the template of non-sense" to describe this world "as presented to us" (for there is no such thing as The Reality...only "the world as we see it)...and non-sense describes "it" all too well. Simply put this article (though not the comment above per se) presupposes "functionality" of this so called "system of finance." All well and good..."provided you ignore what is money" as is done by Chris Whalen (yes, you know who I am Chris...how u doin' better yet...how am i doin'?!!!) here...and all the others who tell us to "get over it." "Cash is King" and it will be restored to that throne whether the "financial engineers" want it to be or not. All that we (I?) are waiting on is for the bankers to suddenly pull back from The Confidence Game and then...truly...does the Government intercede (in the form of a military intervention in my view.) The "government" in the form of the ECB does not a Bank make. The EU is up first for "Big Trouble" because the theory surrounding a currency union is simply flawed. German money is not worth anything to Italians and vice-versa. PERIOD. "CDS contracts"..."insurance"..."banking"..."law"...blah, blah, blah. it's all about anything but actual cash money. even gold is suspect in this world! RATES OF RETURN on the other hand...

Sat, 03/03/2012 - 18:45 | 2220387 Centurion9.41
Centurion9.41's picture

@DisabledVet,

If I understand what you were saying correctly, I agree with much of what you say.  However on this point I disagree; Cash is not king, control of debt is.  Cash is created out of debt, it is debt.  A fact that has a tendency to cause a severe case of cognitive dissonance in many. 

Debt is King because through it one can wet the wants and appetites of men, and create webs to bind them.  Hence the correctness of those who point to the CB's and "banksters" as central to the problem.

Sat, 03/03/2012 - 14:36 | 2219891 FeralSerf
FeralSerf's picture

"These are the politicians and regulators. But these two groups literally sold out the American people to the bankers. Literally."

Did the politicians and regulators sell out or did the bankers capture them lock, stock and barrel? It's an important distinction. The bankers had and have access to capital -- lots of it. That capital elects politicians and appoints regulators. It also kills, both metaphorically and really those that don't play along with their game. It's been a century long process of "boiling frogs" that the people, including the education system, media, politicians and regulators, are gradually conditioned to. The process is getting faster now, because The Bad Guys believe there's no way they can lose anymore.

Those bankers I refer to are not those bankers you refer to in "All across the US there are good bankers in Credit Unions, small banks, etc." The ones I refer to are at the very top of America's power elite, the Lloyds, the Jamies, and their ilk. They are America's elite criminal class. Our system has been captured by them. If you and the rest of America's decent movers and shakers don't believe that, there may not be any hope.

Sat, 03/03/2012 - 17:50 | 2220311 Centurion9.41
Centurion9.41's picture

@Feral,

The piece regarded CDS's, so I tried to focus my comments to them.  Regardless, regarding the points you mention.

re bankers/power elite: I understand.  However words have powerful meaning, especially the less educated the listener.  I fully support naming those who should be called out; Buffett, Diamond, etc.

re your question regarding distinction:  I believe it's a false question.  There was no metaphorical killing.  The politicians and regulators freely took oaths, they were the ones who had the power to kill.   The proper metaphor is the politicians/regulators are the apostles of capitalism.  Like Judas, they sold their souls and the souls of all the disciples of capitalism in the free world.   Money is not the root of all evil.   Men of strength and honor reject such whispers of serpents.   Money merely reveals the true character of a man's ego and soul.

re century long process of boiling frogs: I simply do not believe a cabal of evil men can remain so dedicated for so long, and the history of such groups support such a position.  It's against the nature of such men.   Regardless, I agree with your observation of it being a larger evil that has infiltrated the educational system, media, etc.  I see the financial crisis as merely a battle in a larger spiritual war.

Sat, 03/03/2012 - 15:02 | 2219940 disabledvet
disabledvet's picture

thanks for compliment, i'll take it.

Sat, 03/03/2012 - 12:20 | 2219625 DarkStarDog
DarkStarDog's picture

All this jive... Day after day, week after week, year after year. I guess i've had my fill of Batboy articles. Time to find a nice little tent city cook up some rats and enjoy the great outdoors. Fuck u america ! I quit.

Sun, 03/04/2012 - 11:24 | 2221621 Lost Wages
Lost Wages's picture

My plan is to hoard silver, then buy my relatives' farmland and let it go wild again. The land is best used when nature is allowed to thrive. More bunnies, elk, bison, salmon, berries, tubers, indigenous plants, etc.  The Native American diet. Ahh, it could happen.

Sat, 03/03/2012 - 12:18 | 2219622 urbanelf
urbanelf's picture

They're gonna need meta-CDSs to protect their CDSs.

Sat, 03/03/2012 - 11:56 | 2219602 Catullus
Catullus's picture

"The Greek situation, however, has focused everyone on the basic unfairness of the OTC market model."

What is the basic unfairness of the OTC market "model"?  And while you're at it, explain how an OTC contract is any different than any other private contract. Yes, the bi-laterals are non-standard and have different provisions in their contracts that don't apply to other like instruments.  Sure, you're can make a lot of promises in private contracts that could potential require large outflows of money and decapitalize you quickly, but how is that just because it's called a "swap" that it should and must be publicly reported?

Forcing everyone to report every bi-lateral would require that every individual report every agreement that have with everyone and publicly report the potential impact to the government immediately.  And yes, the CFTC will eventually get to that level of ridiculousness. 

It's obvious what Frank-Dudd is all about: it's legislation written by the largest clearing houses to force all their smaller competitors to either go through the pain of regulatory reporting requirements or force all the derivatives contracts onto a exchange that will require massive amount of regulatory capital to participate, giving the clear advantage to the money center banks.  Most of the electric power and natural gas industries work through Over-The-Counter Bi-Laterals on delivery and there's no reason for them to be going through this exercise.  It's a further consolidation of power in Washington and typical anti-competitive behavior of regulating your competitors out of business. ALL FOR A CRISIS THE BANKS CREATED.

That the rules were rigged for MF Global has to do with Safe Harbor provisions written into federal bankruptcy laws lobbied for by the major banks all throughout the past decade and a half.

Sat, 03/03/2012 - 11:29 | 2219575 williambanzai7
williambanzai7's picture

I don't think anyone on this website is surprised.

Sat, 03/03/2012 - 15:12 | 2219962 The Disappointed
The Disappointed's picture

JSinclair sure wasn't surprised.

Sat, 03/03/2012 - 15:08 | 2219953 disabledvet
disabledvet's picture

I am. Constantly. I mean "don't these people sleep"? Where the hell do "they" come up with all this stuff? I mean "that's an awful lot of energy expended to still have the word loser tatooed to your forehead." Ridiculous. Rip Van Winkle got it "in my worldview." he fell asleep under a tree for 40 years. Congratulations! You won! Sir Isaac Newton, baseball players, girls who found their guy...that about sums it up for me.

Sat, 03/03/2012 - 10:02 | 2219505 puck
puck's picture

The lawyers are dogs. not one lawyer can speak out. not one lawyer not one judge.

What do we need to turn the tables upside down on these guys.

Freekin lunitics, uber sycopaths destroying you and me.

Fucktards starve their asses unplug from the machine.

Sat, 03/03/2012 - 09:45 | 2219484 CulturalEngineer
CulturalEngineer's picture

Good Piece!

"House rules": another name for oligarchy vs. YOU

Its an old story... not really that complicated.

In fact all the complexity serves no purpose other than convincing you that these "must be smart guys so we'd better follow 'em."

Issues in Scaling Civilization: The Altruism Problem

P.S. Stop listening to ignorant Randian "Objectivists"... they don't know their science. (All their think tanks need to address the altruism issue or close up shop.)

 

Sat, 03/03/2012 - 09:39 | 2219478 AN0NYM0US
AN0NYM0US's picture

3 Card Monte  (video)

Sat, 03/03/2012 - 15:22 | 2219986 The Disappointed
The Disappointed's picture

An interesting video if only to see the FRNs flying back and forth between them. Wonder how different the behavior would be if they had to use real money (i.e. gold/silver)

It is easy betting phony scrip.

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