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Any Greek Restructuring Should Be Designed To Trigger A Credit Event

Tyler Durden's picture


From Peter Tchir of TF Market Advisors

Any Greek Restructuring Should Be Designed To Trigger A Credit Event

As talk about an actual restructuring of Greek debt increases, the EU continues to think avoiding a CDS Credit Event is a good thing.  More and more stories and leaks indicate that a real restructuring of Greek debt is on the table, with write-offs of as much as 50%.  Whether it will be real, permanent reductions in principle this time, or some other form of principle protected rollover with a subjective NPV calculation like the 21% haircut, remains to be seen.  In any case, the EU continues to head down the path of bending over backwards to avoid trigger a CDS Credit Event.

They are wrong to be avoiding a Credit Event on the Hellenic Republic.  If they are really pushing for a true restructuring where banks and insurance companies are for all intents and purposes forced to accept a big haircut, they should want to trigger a CDS Credit Event.  They are allegedly avoiding a credit event because it “could unleash a cascade of losses” according to a bloomberg article.  That just makes no sense.  It also seems that pride plays a role as the EU doesn’t want to be impacted by the stigma of a default – a 50% write-off is even, but they don’t want to be called defaulters.  That is plain silly.  They also seem to want to punish speculators, and this is where they really have it wrong, not only are few hedge funds short Greece via CDS at this time, the problems this creates for bank risk management desks is big and will have long term negative consequences for sovereign debt demand.

Bank Credit Risk Management Back to the Dark Ages

JP Morgan is one of the few institutions that have come through the financial crisis with an enhanced reputation.  Their skill for
managing through the problems has been clear and the respect for the firm and Mr. Dimon in particular has grown.  It is their risk management that has been a key to their success.  On their earnings call they were able to point to low “net” exposure to Europe.  They had “Portfolio hedging” for their European exposures of $5.2 billion, 80% of which was related to sovereigns.  So it is possible that JPM was short about $4.2 billion of sovereign CDS to manage their overall exposure to Europe.  If the regulators can pressure banks into taking big write-downs on their positions and make their CDS ineffective, how long before Mr. Dimon realizes he has to do something else to manage his exposure.

If buying CDS is unlikely to provide the relief it should, the only way to reduce economic exposure is to sell assets.  JPM would likely be ahead of the curve and sell their CDS while it still had value, and sell bonds/loans at the same time.  Other banks and investors will eventually realize that they cannot rely on “net” exposures, when the regulators corrupt the product.  Investors will start to focus on gross exposures because they will doubt the ability of banks to ever monetize their hedges.  All the big banks, still likely to be risk averse, even after some multi trillion euro EFSF announcement, will want to maintain low economic exposure to European sovereign debt.  If they don’t believe their hedges will protect them because they would once again be forced to write down assets and not collect on their hedge, the only prudent risk management decision is to reduce assets.

By eliminating a tool for banks to hedge their exposure by blatantly working around it, the EU will reduce future demand for bonds.  Not what they are trying to accomplish.  The whole point of the EFSF and other programs is to stimulate demand for bonds, and they will have achieved the opposite as big banks will have to reduce bond holdings since they will realize they cannot rely on their hedges.

At the other extreme, some weak banks, the ones who likely wrote CDS rather than buying bonds because of the leverage, will want to write even more CDS.  Why would they ever want to buy bonds when the EU just taught them that selling CDS is “free money.”  The weaker the institution, the more appealing that trade will be.  So in the future, the unregulated, difficult to track CDS risk, will all be the hands of the weakest institutions – again, a result that does nothing good in the long run.

The Facts Do Not Show a Risk of “Cascading Losses” From a CDS Credit Event on Greece

According to DTCC, the net Hellenic Republic exposure in the entire system is €2.7 billion.  Yes, the open longs (or open shorts) are a total of €2.7 billion.  That is trivial compared to the €330 billion or so of Greek bonds outstanding.  It isn’t even 1% of the exposure the system has via the bond market.  With a 50% haircut, bond investors will lose about €165 billion, and in the CDS market, a total of €1.3 billion would find its way from the net sellers of protection to the net buyers of protection.  If the regulators and EU are sure the system can handle the bond write-offs, the write-offs for CDS are a rounding error, at best.

What about the “transfer mechanism”?  Isn’t there some way the chain of payments could break down?  There gross notional for Hellenic Republic CDS is €54 billion.  These represent a combination of things, but primarily dealer to dealer trades where one dealer has an ultimate seller, and the other dealer has an ultimate buyer, and the trades run through them since they either don’t fact that client or weren’t the “axe” at the time the client was putting on the trade.  There are also curve trades.  Curve trades will collapse down. The street will run “trioptima” or some equivalent to net the risks down.  Banks are well prepared for the settlement of CDS.  The settlement of Lehman went smoothly in spite of concern at the time.  There is no reason to expect it not to go smoothly this time.  Once again, JPM’s quarterly Earnings Presentation has some useful insights.  They have $8.2 billion of Trading Exposure to Europe, which is “predominantly client-driven derivatives exposure of $14.2 billion, offset by collateral of $6.7 billion (95%+ held in cash).”  I’m willing to assume that JPM is doing a good job on their counterparty risk management.  Other big banks are going to be very similar.

But let’s look at a worst case.  Assume one bank (“Dumb Bank”) has written the entire €2.7 billion of net outstanding Greek CDS.  That bank then owes €1.3 billion.  If the bank doesn’t have the money to pay, they would not pay the money to whoever they sold the protection to.  They would have sold it to one of the “Dealer” banks, one of the 20-30 biggest banks that make markets in CDS as part of their core fixed income platforms.  If they had trades on with several bank, then each of those banks would take a loss.  It would not change their obligation to pay on their contracts?  Does anyone really believe that one of the big banks couldn’t afford that €1.3 billion loss?  It would be painful, but they would absorb it, and the rest of the payments would flow through the system.  They would honor obligation to whoever they sold CDS to, in spite of not receiving the money.  That is how the system works.  The extreme example where one bank provided that much counterparty exposure to one institution that couldn’t pay would is unrealistic, but at least from the CDS chain of events, the losses would end at the big bank(s) that made that decision.  No Contagion.

The Dealer Bank would then proceed against Dumb Bank to collect its claim.  Dumb Bank would enter into bankruptcy in some form or another.  Bondholders would have a loss, and Dumb Bank’s other counterparties would all have to scramble to replace risk.  So this does have the potential to create contagion, but is the market really so stupid that no one would have noticed how bad Dumb Bank’s finances were?  The debt wouldn’t be trading anywhere close to par if the bank had such big exposures and was in that much trouble.  The loss to any single bank from triggering CDS is not likely to be enough to force them into bankruptcy.  Unless a bank has been able to hide massive exposures from the market neither the share price nor the debt of these banks should be significantly affected by monetizing a mark to market loss already priced in, and in many cases, already collateralized.

The system is just not that fragile, and the possible payments from triggering CDS are negligible relative to the losses that will be experienced from the bond market write-downs.  If the EU believes the financial system can handle writing down the €330 billion of bonds (and I believe it can), then it is highly unlikely that the additional losses on €2.7 billion of CDS will be the straw that breaks the camel’s back.  It is just not plausible as the number is small, and the counterparty risk management is actually pretty good, and this would require gross negligence in virtually each and every bank to trigger the contagion risk the EU seems to fear.

Pride and Punishment

An actual restructuring where financial institutions permanently write-off 50% of the principle owed is a default by any other name.  Pretending it isn’t a default so you can say you have never defaulted is just bizarre.  The loss can be called anything you want, but the end result is the same.  Worrying about the semantics of having had a CDS Credit Event is just absurd.  You can say that you “are slightly above ideal weight” but people will still no you are fat.

And who is getting punished?  Reading between the lines, the EU seems to be licking their chops at punishing all the hedge fund speculators who are short Greece via CDS.  Well, guess what?  They are NOT short Greek CDS anymore.  The hedge funds are now generally flat or even long Greece via CDS.  All you need to do is think about it for a moment.    Greece trades at 62 points up front.  So on a $10 million trade, you pay or receive $6.2 million.  If you felt governments weren’t going to manipulate the situation, where would you think the CDS would trade after a Credit Event?  What is the recovery rate then?  I think assuming anything lower than 20% is extremely aggressive.  So you are risking 62 to make 18?  That would require a high degree of certainty, or an even lower recovery assumption.  It would also require you not to have read a newspaper or turned on the TV for the past month.  The G-20, the IMF, the EU, the ECB, are all lined up to try and prevent a default, and even more importantly, continue to state that they want to avoid triggering a CDS Credit Event.  You are making a bet against their ability to circumvent the rules.  From a risk/reward standpoint, I would not be short Greek CDS.  If anything I would have sold Greece CDS here (especially with talk of a 50% settlement).  I would much rather be short French or Belgium CDS.  They have a lot more opportunity to widen, with a limited ability to tighten.

But if hedge funds aren’t short Greek CDS, who is?  Bank hedging desks!  The banks are net short.  The banks do not want to take off their shorts because they don’t want to report larger net exposures.  They aren’t taking profits on these because optically they cannot report to shareholders increased exposure to Greece.  They have done the same analysis as hedge funds and would like to cut their shorts, but this isn’t about making money for the banks anymore, this is about presenting low exposure numbers.  The smart, hedged banks, will be the ones punished.  The EU wants to punish the hedge funds, but all they will do is punish banks that have been most prudent.

And who is rewarded?  Good old dumb bank.  Wrote some CDS because they could get more leverage, and here they are being rewarded by the EU.  The efforts to punish are likely to punish the wrong people and further reward the weakest institutions.  At one time hedge funds were short Greece via CDS, but at one time I was young and athletic – things change over time.  The EU should get over their anger and think responsibly.  That is the only way to truly start correcting the core of the problems.  Lashing out by manipulating markets and rules will do more harm than good.


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Sat, 10/15/2011 - 11:36 | 1776947 Fips_OnTheSpot
Fips_OnTheSpot's picture

How long can a can be kicked?

Sat, 10/15/2011 - 12:38 | 1777047 G-R-U-N-T
G-R-U-N-T's picture

"How long can a can be kicked?"

Vengeance is mine sayeth the CAN as the road ends and woe to the can kickers as you will have my wrath!!!

Sat, 10/15/2011 - 12:48 | 1777082 max2205
max2205's picture

Why the fuck would the writer believe anything that non mark to market JPM would say on an earnings call. 150% of their 'earnings ' in the last Q where from taking their drop in JPM bonds up to the earnings line

What a bunch of crap. CDS 's WILL EXPLODE!!!!!

Sat, 10/15/2011 - 14:52 | 1777274 sqz
sqz's picture

This is a badly written article. Tchir's intent comes across but it reads like garbage to anyone who works in the markets or seriously follows it. It must be a bit of a nightmare to understand for someone new to credit markets.

1. Guy keeps mixing up "short" CDS (i.e. short protection, long credit) with short Greece (i.e. short credit, long protection) and talking about "sold" and "selling" when he means unwind or closing.

2. Anyone who would call JPM ahead of the curve in risk management immediately after they just posted earnings, where more than 27% of it is from their DVA (i.e. extremely controversial booked profits due to losses on your own debt) and that this specifically enabled them to beat their expected earnings, is very deluded or trying to sell some agenda.

3. He critically misunderstands that the primary reason some members of the EU wish to avoid default is due to the seniority of debt and past payouts from the "official" creditors, i.e. IMF, ECB, and bilateral EU gov. funding (and presumably the new crisis funds ESM, EFSF). In fact, you can pretty much boil it down to the ECB being the main blocking point. Unlike the IMF they didn't hand out special loans to Greece, but instead under Trichet (with huge internal controversy especially from the German central bankers) bought Greek debt on the open market like anyone else. This gives little reason for them to be afforded special protection from haircuts or outright default on Greek bonds.

To the ECB, taking a loss on Greek debt is like a bomb going off in their books. It is arguably even worse than if it had happened to the IMF because it is a central bank. Not only are they likely to have to go ask all the EZ governments for money (assuming no asset liquidations like gold ;p), but it creates a precedent and tarnishes their reputation for future crises.

In addition, EU gov. funding to Greece in the past has had no senority over private creditors, this means that if Greek did default again there is no reason why they should be excluded from the losses. This is a significant politcal risk since now they would have to return to their taxpayers and declare they lost money on Greece and, oh look, time to fill yet another budget hole - can anyone donate their first child, etc.

At the rate Greece is bailed out from all official corners of the EU and the rapidly diminishing contribution of private creditors to Greek debt holdings, at some point it will become easier for governments to keep talking up the crisis and just keep bailing out Greece with emergency loans (who knows where from) for years, than it is to even contemplate a loss on their existing payouts.

What's ironic is that if you actually look at the figures, without all this interference, Greece would need to repudiate its outstanding debt completely (while retaining the ability to recapitalize its banks) in order to achieve an actual reduction on their total debt. Due to the mixing of official creditors with private creditors, mainly due to the ECB, it's in Greece's interest not to do anything at all but just wait for the money to come in drips.

That is, to hell with moral hazard, ECB/EU wants to save its reputation at almost any cost to their taxpayers.

Sat, 10/15/2011 - 14:58 | 1777301 Lord Welligton
Lord Welligton's picture

Well argued.

However I would disagree on a "continuing crisis" and endless drip-feed to Greece.

I think things will come to a head before long.

It's one thing for King Canute to claim he can hold back the sea.

It is an entirely different matter to put it into practise.

Sat, 10/15/2011 - 16:59 | 1777580 falak pema
falak pema's picture

well when poseidon becomes angry it ends up in tsunami. Even in the Medit. So its worth meditating.

Sat, 10/15/2011 - 16:59 | 1777583 spdrdr
spdrdr's picture

Canute never claimed to be able to hold back the sea.

He famously demonstrated this to his many followers (who thought he was a god), by ordering the incoming tide to cease - and failed miserably.

Sat, 10/15/2011 - 17:22 | 1777618 Lord Welligton
Lord Welligton's picture

I was aware of that at the time of writing.

I was using the common knowledge of Canute.


Drawing the myth truth out ........

Who will be Canute today?

Who will say that the tide is running out on the West?

Who will lead like Canute?


Sat, 10/15/2011 - 15:24 | 1777354 oogs66
oogs66's picture

It seems that Europeans like to talk about CDS in terms of protection so long or bought means short credit risk. Americans tend to talk about it in terms of risk - so long or bought means long credit risk. Another added level of confusion to this product.

Sat, 10/15/2011 - 16:44 | 1777554 Ghordius
Ghordius's picture

Yes - Investing vs Betting mindset


Take the live grenade from those juvenile's tentacles.

Sat, 10/15/2011 - 16:50 | 1777570 Lord Welligton
Lord Welligton's picture

Or leave the grenade with the juvenile's testicles.

Sat, 10/15/2011 - 16:38 | 1777540 falun bong
falun bong's picture

and in principle you should spell principal the right way

Sat, 10/15/2011 - 17:04 | 1777590 spdrdr
spdrdr's picture

I don't no about that!

Sun, 10/16/2011 - 10:20 | 1778667 disabledvet
disabledvet's picture

I disagree totally with this article being a piece of garbage. To me it makes perfect sense: "the problem is that the banks are" (as they always are) "net long." This is the whole basis for Credit Default Swaps. Before this item was created simply put there was no insurance for financial entities that have been scaled up to manage their risk. The hedged risk vis a vis Greece...and i imagine all the other nations of Europe (relative to the risk) is without a doubt so small as to be a rounding error relative to the net long exposure. In short "the countries are destroying their banks" which given the size of the financial system relative to actual nations does in fact put the individual nations at risk (riots in the street)....whereas in the USA the interest is only in nationalizing them apparently. Anywho "Europe's up first." Perhaps the member States of the EU are just trying to "cut their banks down to size" (maybe the elected leaders are just trying to run their countries?) but as is obvious these actions have meant "cutting your country down to size." Since no one wants the benefit cuts in each of the member states of the EU it all comes down to recognizing the the fact the entirety of the European Banking sector has a net long exposure and not as it presented in the MSM "mere exposure" at all. In other words this isn't "kicking the can down the road" at all but in fact simply being in denial--or worse. Since all we need to do in our analysis is "simply see what the people in The Street are doing as a conesquence" we can simply dispense with the ridiculous argument of mere "moral hazard" as presented above. This is SECURITY HAZARD...and not a mere moral one. Insofar as "the currency rises in value as country so and so explodes in an orgy of violence"....well, "that must be those little countries." Again...we shall see what the consequences of the now global movement now known as "The Occupation" truly is. When the media starts "complaining" that "anarchists" are "hijacking the movement"...well, let's just say it sounds rather American. Hard to imagine "it all started with a unemployed fruit vendor." Amazing.

Sat, 10/15/2011 - 17:10 | 1777598 Sam Clemons
Sam Clemons's picture

The energy stats don't lie.  The can kicking is clearly not working in the real world.

For those of you who liked my energy, historical bull market charts, I updated them for the first time in months.  Also have some info on where we are headed in the short term.

Sat, 10/15/2011 - 11:39 | 1776954 agent default
agent default's picture

Greece should default big, should default loud, and should tell the Eurocrats to shove it.  I do not understand why the decision fo weather to default or not, is not something for Greece to decide, but something for the EU.  This is nonsense of  the highest degree.

Sat, 10/15/2011 - 15:12 | 1777325 Divine Wind
Divine Wind's picture

I think Greece has given up this right with prior rounds of funding.

Threat Journal recently carried a video with Max Keiser that explains much of it. Incredible.



And behind it all?  Goldman Sachs.

Sat, 10/15/2011 - 15:29 | 1777366 Lord Welligton
Lord Welligton's picture

And this from the traitor Papandreou.

"We are not Atlas which can take all Europe's problems on his shoulders," he said, referring to a Greek mythological figure who supported the heavens on his shoulders. "If Europe cannot solve its problems, the consequences will be unpredictable for all of us in Europe."


Sat, 10/15/2011 - 16:11 | 1777467 DosZap
DosZap's picture

agent default

Reason?,easy...................................FREE CHIT.

Suck that teat as long as it puts out. Greece(and several others are) basically WELFARE soverigns.

Who the hell wants to have to do it thereself.When they can get it free.


Sat, 10/15/2011 - 16:41 | 1777547 Bwahaha WAGFDSMB
Bwahaha WAGFDSMB's picture

How big is the Greek army?

Sat, 10/15/2011 - 16:47 | 1777561 Ghordius
Ghordius's picture

It's the biggest of the world
and it's called NATO

Sat, 10/15/2011 - 11:47 | 1776979 holdbuysell
holdbuysell's picture

The complexity of the system is ridiculous. These jackwagons have wrapped themselves around the axle so tightly, there's no more room to move.


Sat, 10/15/2011 - 12:36 | 1777066 Rainman
Rainman's picture

Profit from failure is a grimy, unethical and immoral business. And business has never been better.

Sat, 10/15/2011 - 13:19 | 1777140 rocker
rocker's picture

That is why Goldman always wins. Throughout the summer they took trillions out of the market.

 Now people are leaving in mass.

So Goldan and their special algo manipulating software is taking the maket up to attract new money in.

Hence, Rinse and Repeat. Just went they suck in enough money again. The Squid will suck it out again.

There is no more proof for me that Goldman Rules the World as the BBC guest said.

When Greece had their Riots they had banners with Goldman Sachs on them all over the place.

That is not something that was a illusion, it was reality that Goldman is in part to blame for the people's downfall.

It is terrible of CNBC to leave people under the impression that the Bailout of Greece was for the people.

It is not, the bailout would be mostly for the bond holders. bond holders mostly being the Banks and the elite who

control the banks.  Dam, it's always the banks.

Sat, 10/15/2011 - 19:26 | 1777856 JohnG
JohnG's picture

Said one lawyer to another?

Sat, 10/15/2011 - 11:47 | 1776981 falak pema
falak pema's picture

If greece had patriotic leaders it would default loud and clear. Let Eu handle its banking fall out. Unfortunately, Greece has Oligarchs, part of Euro construct. Paid shills who lied then as they lie today and let their people pay to save their banker friends.

Sat, 10/15/2011 - 11:53 | 1776990 bank guy in Brussels
bank guy in Brussels's picture

Peter Tchir writes above:

« ... Dumb Bank would enter into bankruptcy in some form or another ... »

Dumb Bank - I think many of us have had an account there at some point ...

Sat, 10/15/2011 - 11:55 | 1776992 dasein211
dasein211's picture

Theyre scared to death because they know that the off market dark pool derivatives would crush everything. Its not what we see in the open. Its whats under the sheets. There is no other explanation. With what we know in the open it makes sense to mark it all down and take the loss but theyre hiding a derivatives nuke that will take out everyone and they know it... Or a few know it and are trying anything to stop it.

Sat, 10/15/2011 - 12:00 | 1777006 agent default
agent default's picture

This is not Greece's problem. It's their problem.  Greece should tell thm to fuck off.

Sat, 10/15/2011 - 12:02 | 1777012 CrashisOptimistic
CrashisOptimistic's picture

DTCC is not comprehensive anywhere and certainly not in Europe.

Sat, 10/15/2011 - 13:16 | 1777135 oogs66
oogs66's picture

why the hell isn't this stuff on an exchange yet?  really it is getting close to 4 years since Bear and this huge product, is still completely hidden....insane!  regulatory failure...complete regulatory failure, but hey, we can do operation twist - what a joke :D

Sat, 10/15/2011 - 14:56 | 1777298 Mike2756
Mike2756's picture

'Cause they fought it. No market for that garbage or, was it something else?

Sat, 10/15/2011 - 15:19 | 1777343 Absalon
Absalon's picture

The market in interest rate swaps is so totally disproportionate to the amount of hedgeable debt outstanding that most of the swaps are probably being used for some inappropriate purpose - probably tax avoidance - and creating systemic risks as a side effect.

Sat, 10/15/2011 - 15:35 | 1777378 kaiserhoff
kaiserhoff's picture

Good point.  Ditto for the volume in FX transactions.  Barrons got their panties in a knot over this for a while.  Speculation was that much of it was money laundering from crooks and cartels.  No one seems to want to look too closely. 

Sat, 10/15/2011 - 12:16 | 1777037 Manipulism
Manipulism's picture

For example Ackermann knows it for shure.

Sat, 10/15/2011 - 13:31 | 1777165 end da fed
end da fed's picture

please help me understand derivatives...

Sat, 10/15/2011 - 16:26 | 1777514 kaiserhoff
kaiserhoff's picture

Start with any well written book on stock options: puts, calls, basic strategies.

Don't try to deal with bonds unless you want to be a specialist or a drooling, muttering nincompoop like the rest of us;)

Sat, 10/15/2011 - 17:07 | 1777594 end da fed
end da fed's picture

ok thanks

Sat, 10/15/2011 - 11:57 | 1776998 CrashisOptimistic
CrashisOptimistic's picture

Worshipping at the altar of DTCC's measurements of CDS exposure is a particularly bad idea, especially for European insurance, which may not clear through DTCC.

Sat, 10/15/2011 - 12:14 | 1777034 dvp
dvp's picture

Fascinating is the article's passage, "a true restructuring where banks and insurance companies are for all intents and purposes forced to accept a big haircut."  "Haircut" appears to be the term du jour in the popular "economics, business, finance" media.  Exactly what does it mean?  Does it mean what it meant during the "terror" in the French revolution?  Now those were "haircuts!"

Sat, 10/15/2011 - 13:13 | 1777128 oogs66
oogs66's picture

the 21% number they kick around the first time was a pack of lies...the banks were going to keep booking it at par and greece still owed all the money, just over a longer period.  every plan is conceived to deceive

Sat, 10/15/2011 - 15:44 | 1777402 Mike2756
Mike2756's picture

It's more than that, you're talking pension funds, etc.

Sun, 10/16/2011 - 00:46 | 1778326 Zero Debt
Zero Debt's picture

How about "take a massive loss on a lousy sucker's bet gone bad"? But wait that is not doubleplusgoodspeech..

Sat, 10/15/2011 - 12:34 | 1777062 Market Efficien...
Market Efficiency Romantic's picture

Doesn't it look like an inofficial European assessment of net CDS issuance? If US banks were the issuer of Greek sovereign and bank CDS, the EU would take cracks to its reputation but would sure agree to let default. Maybe, European CDS writing on Greece has been more active than generally anticipated, demanding a non-evenmt default. But then again, especially for the large banks, aka Deutsche, SocGen etc, Greek exposure had always been netted of CDS protection. Without protection, their situation would sure look vastly different from what anyone including EBA expects.

Sat, 10/15/2011 - 12:42 | 1777073 Lord Welligton
Lord Welligton's picture

There are those who say the derivatives are a zero sum game.

They are correct as long as all of the counterparties can meet their liabilities.

But it doesn’t take much for the entire market to implode.

@ $600 Trillion if only .1% fail to meet their obligations that is $600bn.

@ $600 Trillion if only .05% fail to meet their obligations that is $300bn.


Sat, 10/15/2011 - 13:14 | 1777131 Market Efficien...
Market Efficiency Romantic's picture

I would look at if from a little differerent perspective, however with the same fatal result:

The majority of the 600T are IR swaps, not being influenced directly. And even in the CDS market, only a portion is issued to Eurpean sovereign and Eurpean banks. However, let the relevant market be 20T, if one core column drops, the entire pyrimad drops, eventually also pulling the columns in other derivative markets.

My argument has been, bank recapitalization does not change anything material, as a crack in the derivative chain will despite any recapitalization take down the entire house of cards. I am really wondering, how G20 governments possibly think to safe a derivative chain reaction.

Sat, 10/15/2011 - 13:18 | 1777139 oogs66
oogs66's picture

if one core dumps, just like lehman, it will be losses on bonds that crush the system, not the guess we just never let anyone default - world is insane....

Sat, 10/15/2011 - 13:34 | 1777172 Lord Welligton
Lord Welligton's picture

But it is the existence of CDS that allows banks and insurance companies ignore the scale of the losses.

If the CDS market is shown to be less than robust a lot of balance sheets will have to take a hit.

Sat, 10/15/2011 - 14:09 | 1777231 oogs66
oogs66's picture

yes the system is convoluted beyond recognition and the reluctance to force it on to an exchange or in the open is basically criminal...such an important part of the market remains opaque and feeds the fear and greed causing too much volatility...the solution - exchange - is so simple and beneficial it is just amazing that still nothing done...

Sat, 10/15/2011 - 15:09 | 1777322 Lord Welligton
Lord Welligton's picture

I agree. A transparent market would help price discovery.

But I'm not holding my breath.

In the meantime we have absolutely no idea how the banks and insurance companies arrive at the valuation of derivatives on their balance sheets.


Sat, 10/15/2011 - 13:31 | 1777166 Lord Welligton
Lord Welligton's picture


I put those numbers out merely to show the fragility of the system.

Your analogy of columns is equally persuasive.


If there were no problem the ISDA would allow a credit event on a Greek default.

All of this PSI (Private Sector Involvement?) in a "voluntary" "restructuring" is pure BS in the absence of there being a problem with derivatives.

Sat, 10/15/2011 - 14:41 | 1777272 Absalon
Absalon's picture

There is something hinky about that 600 Trillion dollar amount.  Even allowing for double counting etc the number is out of whack with the real world.  The biggest governance failure of the last four years is the failure to bring derivatives under some sort of control.

Sat, 10/15/2011 - 14:50 | 1777290 Lord Welligton
Lord Welligton's picture


I have read elsewhere that there are $1.5 Quadrillion of derivatives (notional value) outstanding.

I'm convinced there is a problem. Can't prove it.

I am unpersuaded by Peter Tchir's argument.

Sat, 10/15/2011 - 17:14 | 1777607 falak pema
falak pema's picture

these are notional numbers and in fact the outstanding cumulative position is more like 200T. (not being counted twice).

Even 200 T unwound and written down is mindboggling. And more importantly unsustainable.

Sun, 10/16/2011 - 00:50 | 1778333 Zero Debt
Zero Debt's picture

You can't legislate against bad bets but you could at least create a central clearing house that could monitor total positions outstanding and then perhaps enforce some form of position limits... as well as separating proprietary trading from being a custodian of other people's money.

Sat, 10/15/2011 - 12:46 | 1777079 oogs66
oogs66's picture

It is criminal that almost 4 years after bear stearns that CDS isn't on an exchange.

Sat, 10/15/2011 - 13:31 | 1777167 sqz
sqz's picture

It's criminal that CDS haven't been banned, especially when on one side they are almost impossible to trigger, thus defeating the true reason of their existence. On the other side, they are meant to disintermediate credit risk but instead TBTF entities warehouse and hoover them up and use them as a leveraged means to increase systemic risk through the financial sector due to broken accounting rules and short term compensation culture.

It's like a double whammy. TBTF shouldn't exist. But even if they didn't exist, the presence of CDS would mean many entities could all fail at the same time due to the systemic leverage from many being able to sell insurance on the same names and they in turn being insured again many times.

CDS really isn't like any other derivative contract from a systemic perspective. In any other industry, if an item risked causing the kind of chaos and damage that CDS can, it would be banned. Unfortunately, the regulators are both incompetent and under political capture, making it impossible to regulate almost any aspect of the derivatives markets.

The system is so broken it is scary, but at the same time it does give rise to certainties: many more and deeper financial crises will re-occur in the "developed" world. Prepare, while you can.

Sat, 10/15/2011 - 18:00 | 1777692 oogs66
oogs66's picture

CDS, but credit as a whole, has similar risk as put options on equities, but put options are fairly volatile and no one writes deep out of the money one in meaningful size.  On CDS and credit, the normal moves are small so position sizes are huge, and when the sh*t hits the fan, it gets really ugly in a hurry.

Sat, 10/15/2011 - 13:00 | 1777105 BadKiTTy
BadKiTTy's picture

Lost me a bit!

Perhaps I am missing the point here, but CDS is an 'insurance' backed by sweet FA and so perhaps a non credit event is needed to avoid the obvious fact that the counterparties cannot pay.

So the game seems to be ''make money selling hedging products that will never need to be used'. Charles Ponzi would be proud.

The system is not so complex that TPTB end up with all the £.

Strange that!


Sat, 10/15/2011 - 13:21 | 1777149 Market Efficien...
Market Efficiency Romantic's picture

Depends on then refional and structural net issuance. Lets say hedge funds wrote a major stake of the outstanding sovereign CDS, as some argue, and banks in certain refions would be net long protection, their risk management would almost require a credit event. The other way around, the EU banks would at all cost try to avoid a credit event and agree to large haircuts, but will their share suffice to accept the haircut without stating a credit event.

As you see, pure speculation, I guess, that's exactly the question, driving the decision taking by politicians. Just without a reliable statement from EU banks, hm, tough decision.

Sat, 10/15/2011 - 13:06 | 1777117 lapedochild
lapedochild's picture

Naive question... the 21% was 'volunary'. With the banks now up in arms of paying more, this will be clearly involuntary. Would such a thing not by its nature be a credit event and trigger the CDS's? You can't have your came and eat it too.

ECB's Juergen Stark very much against higher writedowns, since another nasty side effect is that the EZ can't be trusted and hence yields of all countries and especially of the PIIGS will shoot up...


Sat, 10/15/2011 - 14:06 | 1777222 oogs66
oogs66's picture

its because the ecb will look stupid and have big losses and have their bond buying powers taken away

Sat, 10/15/2011 - 13:17 | 1777138 EagleProjets
EagleProjets's picture
Greece economy: More pain October 14th 2011  



The troika of representatives of the IMF, European Central Bank and European Commission are expected to release the delayed sixth tranche of emergency loans to Greece in early November, having secured the Pasok government's agreement to implement another new round of austerity measures. These include a property tax costing the average homeowner €800 from 2011, a sharply reduced income tax allowance, salary cuts and the layoff of 30,000 public-sector employees. But with economic activity in Greece continuing to plummet, the Economist Intelligence Unit forecasts that the revised austerity programme will reduce the government deficit only moderately. A significant write-down of sovereign debt in 2012, if not before, is unavoidable.

Earlier this week the troika of monitors from the European Commission, the European Central Bank (ECB) and the IMF finally issued a statement that they were broadly satisfied with additional austerity measures the Greek government was now planning to take to bring down its budget deficit for 2011 and 2012. Amid evidence of clear slippage in the government's fiscal reform programme, last month troika representatives had walked out of discussions with an implicit warning that the Panhellenic Socialist Movement (Pasok) government commit to more effective deficit-reduction policies in order to secure continued emergency financing. Greek policymakers have since agreed to an extra €7.1bn of spending cuts and tax rises in 2011-12, including a highly contentious property tax. As a result, the troika has approved the release, most likely in early November, of the delayed sixth tranche (of €8bn) of the May 2010 emergency loan facility.

However, this decision by the troika represented a clear climb-down from its previous strict demands for Greece to meet this year's mandated fiscal target. Budget data for January-July were deeply discouraging. Linearly extrapolated, the seven-month general government budget results implied a deficit to GDP ratio of the order of 14% of GDP, well above the estimated 2010 outturn of 10.4%. Although revenue growth should accelerate to some extent in the final months of 2011, it still seems likely that the deficit will exceed 9% (or even 10%), compared with the 7.6% target "agreed" by the government and troika in June. Belatedly acknowledging the impossibility of meeting this objective, given the continued collapse of the Greek economy and a lack of progress in many areas of the reform programme, EU/IMF officials fudged the issue by stating that evaluation of Greece's deficit-reduction efforts would now be based on a "combined" target for the public finances in 2011 and 2012.

The troika also only agreed to sign off the latest round of bail-out funds after reaching agreement with the government that "additional austerity measures are likely to be needed" in 2013-14, most likely further public-sector wage and pension cuts. According to the statement released by the troika at the conclusion of its review mission, such measures will be adopted by mid-2012 in the context of an update to the official Medium-Term Fiscal Strategy (MTFS) up to 2015, which the Greek government and parliament had committed to in June.

Tough ask

In urging the rapid implementation of the latest round of austerity measures, the troika had indicated that it favoured two-thirds of the adjustment to be made via expenditure cuts and one-third through revenue increases. However, the government plans involve a larger share of measures targeting higher revenue. It intends to boost receipts by €4bn (1.8% of GDP), mainly through a new property tax and further cuts in personal income tax allowances, as well increasing the tax on heating oil. Reduced expenditure of some €3.1bn (1.4% of GDP) is assumed to come by means of cuts in public-sector wages and pensions and, eventually, layoffs.

The property tax is targeted to raise approximately €2.5bn (1.1% of GDP) annually. When first announced it was to apply only in 2011 and 2012 but subsequent announcements have said that it will run at least until 2015. If collectible, the new tax looks likely to become permanent. The formula for calculating the tax is based on the size of a property (measured in square metres) and the objective value assigned to its location, multiplied by a co-efficient related to its age. The taxable charge ranges from €3/square metre in poorer districts, where the objective value is €500/square metre, to €16/square metre in upmarket neighbourhoods, where the assigned value is in excess of €5,001 per square metre. The average charge is estimated to come in at €4/square metre and the average tax at €800 a year. Indicative of the difficulties the government faces in revenue collection is the decision to collect this levy through electricity bills. The trade union of the state-controlled Public Power Corporation has said its members will not participate in the collection process.

Cuts in tax allowances are supposed to raise around €2bn (0.9%) of GDP. The tax free income allowance for personal income tax is to be reduced to €5,000 (the June MTFS had introduced a reduction to €8,000 from an original €12,000). The measure will apply to 2011 taxable earnings to be reported for purposes of taxation in 2012. It seems that a rate of 10% will be charged on the first bracket up to €15,000. This, it has been calculated, would catch 1.2m people who will pay tax for the first time in a range of €50 to €300 a year and could add up to €700 to the bill of existing taxpayers. An estimated 2.9m people will continue to report net taxable income below the threshold.

On the expenditure side, a new unified pay scale for the civil service is designed to provide an average 20% cut in wages to generate savings of €150m this year and €950m in 2012. (This is in addition to average pay cuts already made of 15% for civil servants and 25% for employees of state-owned enterprises.) Based on the principle of equal pay for equal work, it is designed to eliminate many bonus and benefit supplements that have been negotiated ministry by ministry creating extensive differentiation in final pay packets. Salaries are to be capped at €2,200 a month (excluding productivity and responsibility bonuses that can amount to a further €500). Meanwhile, further cuts in pensions are designed to produce a 4% reduction on average in the pension bill (in addition to a 10% cut already implemented). Independent analysts have suggested as many as 450,000 pensioners could be affected by the latter move.

The government has reiterated its intention to hire only one person for every ten who leave (instead of its original ratio of one for five). It is committed to reducing its headcount by 150,000 by 2015. Thirty thousand public employees are to be placed on “reserve” status and ministers have been given until the end of 2011 to identify candidates who will receive 60% of their current pay for one year. They will have the right during the year to apply for any public sector job that comes open, but without any priority status. If they have not found a new post within the year, they will be made redundant on full pension.

This would set a precedent as, until now, all public-sector workers made redundant from public agencies privatised or restructured have been offered places elsewhere within the public sector. The measure would appear to apply, however, only to workers in the broader public sector, as civil servants enjoy constitutionally guaranteed tenure. As with many of the reform measures, it remains to be seen whether this measure can be implemented against deep resistance.

The Economist Intelligence Unit
Sat, 10/15/2011 - 13:40 | 1777182 Sockeye
Sockeye's picture

It seems like the French are the ones really behind this "face saving" crap.  Knowing what I know about that culture it doesn't surprise me.  I saw firsthand how gleeful the Euros and particularily the French were in 2008 at the height of the financial crisis, they were soooo pleased that TSHTF in the US and not in Euroland.  They were smacking their lips at the prospect of buying oil and cheap China trinkets in Euros instead of USD.  So now they have to admit their shit stinks too.  Painful to acknowledge that the Savoir-faire culture also has a bit of baked-in gaucheness. 

Sat, 10/15/2011 - 16:24 | 1777507 DosZap
DosZap's picture


It seems like the French are the ones really behind this "face saving" crap.

Au Contrarie!!!.

THEY have the most EXPOSURE to Greece defaulting,their Banks are screwed if Greece walks.

That's the reason.

Sat, 10/15/2011 - 13:47 | 1777194 Restcase
Restcase's picture

Good piece - excellent points, really. "And who is rewarded?  Good old dumb bank." This needs a comment.

Dumb Bank - formerly the First CityWide Change Bank - gets to keep the status quo. Smart bank gets to keep collecting CDS premiums.

I do think the domino effect is more on the mind of EU bigs than the "shame" of default.

Sat, 10/15/2011 - 14:21 | 1777221 FinalCollapse
FinalCollapse's picture

I suspect there is another moronic AIG in Europe  and most likely it is a Frenchie. 

The default event must happen, no matter what Sarkozy thinks and wants. By manipulating it, they murder the financial markets, the free enterprise, and the risk management. There is no such thing as free lunch. If there is a bank in EU that sold too many CDS and cannot pay its obligations, than this bank must go bankrupt. They need to reset the risk in Europe, and stop beating the fucking bushes.

CDS should be traded on Exchange, and it should be transparently reported on the balance sheets. Fuck these socialists in EU - and USA.


Sat, 10/15/2011 - 14:15 | 1777238 bigbucksr
bigbucksr's picture

The Europe situation reminds of the whole aig CDS fiasco, where the federal reserve bailed out the bookie (aig) when they couldn't pay off all of their CDS bets with Goldman Sachs. I say let the chips fall where they fall....if you make a bet with a bad bookie who goes bankrupt and can't pay off their bad CDS bets then that is your problem, not mine, and not the taxpayer, and certainly not the us taxpayer......For me, that was the crime of 2008....the us taxpayer paying Goldman sachs 50 billion dollars as part of the aig bailout

Sat, 10/15/2011 - 14:19 | 1777246 Everybodys All ...
Everybodys All American's picture

How is any haircut not a credit event? The CDS market is just another scam security type in which the banks (ISDSA in this case) decide "heads I win tails you lose".

Sat, 10/15/2011 - 14:46 | 1777283 RSloane
RSloane's picture

This is better than three-dimensional chess!

Sat, 10/15/2011 - 15:03 | 1777310 Atomizer
Atomizer's picture

Many of you are spot on. Let me tell you a story about a person who decides the fate of four trains verging into one another. The dispatcher can radio in, slowdown, speed up or sit idle. Due to the debt saturation crisis, the dispatcher is told to follow the new train derailment procedures. Little does the dispatcher realize, one of those four trains will create the next che'ange in completing central planning goals.

Stanley Milgram Shock Experiment

As each day approaches, the level of shock news therapy will intensify until no one can believe the lies.

Sat, 10/15/2011 - 15:16 | 1777335 Lord Welligton
Lord Welligton's picture

We inflict pain (austerity) on our fellow citizens because the banks (test controller) instruct us to do so.

Even if it goes against our instinct.

Sat, 10/15/2011 - 15:06 | 1777313 zilverreiger
zilverreiger's picture

Americans start focussing on your own shit, your nation is in worse shape than Portugal. No amount of blocking financial taxation,  videos of chinese failures, or fake Iran plots, or praising jesus is gonna stop it.

Sat, 10/15/2011 - 15:19 | 1777345 Atomizer
Atomizer's picture

Calm down young lad, your falling for the divide a conquer bullshit that was used centuries ago. Bond, not divide. :)

Sat, 10/15/2011 - 17:02 | 1777587 zilverreiger
zilverreiger's picture

I'm not necessarily falling for that, I just noticed ZH's falling for it.

Sat, 10/15/2011 - 15:08 | 1777318 London Banker
London Banker's picture

I know it's a bit pedantic, but "principal" is the amount of a loan or debt obligation, whereas "principle" is a an ethical construct.  In principle, the loan principal should not be preserved from writedown in a default scenario.

Sat, 10/15/2011 - 15:49 | 1777409 Atomizer
Atomizer's picture

Oh my fucking word... LB posts. I feel a moment of being sucked into a vacuum of time. Keep up the snippets on your blog. Back in the day when ZH was low tech, you taught me so much. Thank you.


Sat, 10/15/2011 - 15:09 | 1777320 long_and_short
long_and_short's picture

These austerity measures are a death spiral. 

Really need to default then rebuild your system.

Sat, 10/15/2011 - 15:21 | 1777349 Atomizer
Atomizer's picture

Really need to default then rebuild your system.

What system do you have in mind?

Sat, 10/15/2011 - 15:39 | 1777387 vote_libertaria...
vote_libertarian_party's picture

What's the big worry?  CNN has an article today that says the G20 and Timm-ay G will stand behind any problems and fix all of this mess.

(sorry, can't copy link)


un frickin real


Sat, 10/15/2011 - 15:43 | 1777401 devo
devo's picture

That fuckface better stop spending my tax dollars on Greece.

OWS needs to get violent on his ass.

Sat, 10/15/2011 - 16:31 | 1777527 Atomizer
Atomizer's picture

OWS needs to get violent on his ass


Quite the opposite assclown. You can breakdown the agenda, not the peeps. Reading the Playbook either helps or hinders your charter mission

**Must Read**


an influencing of one's own attitudes, behavior, or physical condition by mental processes other than conscious thought.


Joy Division - Autosuggestion


DEVO, while you were taught in skool to steal to get ahead. A generation ahead saw beyond the forest. We made money to create jobs.

Sat, 10/15/2011 - 15:39 | 1777388 slackrabbit
slackrabbit's picture

>Their skill for 
>managing through the problems has been clear and the >respect for the firm and Mr. Dimon in particular has grown.


You're joking right?

Sat, 10/15/2011 - 15:42 | 1777396 devo
devo's picture

Obviously they should just default and leave the EU.


Sat, 10/15/2011 - 15:55 | 1777420 buzzsaw99
buzzsaw99's picture

JP Morgan is one of the few institutions that have come through the financial crisis with an enhanced reputation...


Sat, 10/15/2011 - 16:20 | 1777502 kaiserhoff
kaiserhoff's picture

Well, if you don't specify what was enhanced...

Sat, 10/15/2011 - 17:06 | 1777591 falak pema
falak pema's picture

derivatives hard-on...beyond redemption. DSk would be proud.

Sat, 10/15/2011 - 17:33 | 1777639 Lord Welligton
Lord Welligton's picture

Jamies bonus?

Sat, 10/15/2011 - 16:35 | 1777535 JLee2027
JLee2027's picture

Bollocks indeed of the highest order.

Sat, 10/15/2011 - 18:27 | 1777745 mendigo
mendigo's picture

Greece has already defaulted - others are now paying their bills. The Europeans are hoping nobody notices. They cannot allow a credit event because that might impair their efforts to appear it is all under their control. It is fun to watch their weak attempts at arrogance.
Similarly the us has already defaulted - we are paying our bills with puny money.

Sat, 10/15/2011 - 19:46 | 1777892 colfaxcap
colfaxcap's picture

SQZ, you are entirely correct. Tchir's articles are coming across more and more like a junior analyst at an internship is doing the writing.

Sun, 10/16/2011 - 12:10 | 1778824 Stuck on Zero
Stuck on Zero's picture

You'll be happy to know that the containership MV Rena that went aground on the Astrolabe Reef in the Bay of Plenty, New Zealand, is a Greek ship!

Sun, 10/16/2011 - 18:58 | 1779585 RMolineaux
RMolineaux's picture

Tyler -  While I agree with you that not calling a 50% haircut a default is totally ridiculous, I would like to ask why a relatively small amount of CDSs is allright, while a larger amount would be catastrophic.  If it is a bad idea on a large scale, why would the small scale use be OK?  The fact that this "protection" has happily been used by only a few, IMO demonstrates that the use of CDSs has not had the beneficial effect on the market that is claimed, but is rather a risky side bet invented by the clever to entrap the stupid.  I also disagree with you that there is sufficient sophistication in the market at large to detect possible future defaults.  Look at AIG.

Sun, 10/16/2011 - 19:01 | 1779592 RMolineaux
RMolineaux's picture

Apologies to Tyler.  I thought this item was his own post and not Tchir's.  I'll be more careful next time.

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