Did Basis Traders Save The Euro-Zone (For Now)?

Tyler Durden's picture

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Ahmeexnal's picture

Idiots, they will be handed their balls on a platter.

TheSilverJournal's picture

Buying insurance against default makes no sense. If the fiat ponzi collapses, how do the buyers of the insurance think they will get payed?

Schmuck Raker's picture

Perhaps some view the world as not just black or white?

ebworthen's picture

Good question.

They bundle the insurance into swaps and have retirees, pension funds, municipalities, and mutual funds to buy it at AAA ratings.

When the ponzi collapses, the bill is passed to the central banks, who pass it to governments, who pass it to the average working citizen and their unborn children in the form of "austerity" and future debt.

It is an engineered form of theft, of skullduggery - using "economics" and "judicial process" and "banking" of supposedly educated and "moral" people in nice clothes to do the robbing.

In the old days the Czar or King or Shogun would have roving bands of mercenaries beat people over the head for tribute.

Isn't this better?

</sarc off>

Going Loco's picture

"They bundle the insurance into swaps and have retirees, pension funds, municipalities, and mutual funds to buy it at AAA ratings."

That is what I have been thinking. When I hear people like Hendry and Bass talk about their plays on collapse I always find myself thinking, who have they got as a counterparty that will still be able to pay if the event occurs? And the only answer I can come up with is that somehow the thing has been engineered so that their counterparties will have an automatic government backstop. Not saying these guys are wrong to do such a thing (if this is indeed what they are doing) but really that just gives us the same circular path to the same outcome which is that the middle class will pay for all this.

jm's picture

(Most) basis traders don't care about default and determination.  The basis trade is simply a short-long strategy on spread moves.

Maybe this is more about the effectiveness of bond purchases... once cash bond spreads or CDS premium stabilize at a line in the sand, then they drop out of the "default condition red" zone as basis traders then step in.  Then others like insurers follow because  markets can source liquidity again.

I admit this seems weird, because if there is no way to get an honest determination in sov default (aka the Greece haircut), there is no effective protection in a CDS position... no real "short" leg.  It becomes just another way of picking up pennies in front of a steamroller.  But everything else is exactly the same given a long enough timeline.

Manthong's picture

I don't understand it.

Doesn't the very concept of "voluntary haircut" make the whole damn process a theater of the macabre?



jm's picture

If you hold a bond, you fear default.  If the ECB comes in and buys secondary bonds (probably bought at auction through a SIV, and probably will have to take delivery on futures) with enough size to draw a line in the sand on spreads, it is a big signal. When the market tests resolve, and they are willing to be the buyer of last resort, then you lessen/marginalize default risk.

For buyers with a deep-seated belief in the near-equivalence of short CDS and long bonds, this is good enough because they care about spread moves.  When these guys step in arb the spread, then the rest of the ecosystem steps back in.  Is default risk gone?  Well, if you can count in the ECB to not be idiots, then it is reasonable.

It is like picking up pennies because you are not depending on balance sheets to determine credit risk.  You are depending on an outside buyer to put a bid under government securities that no one would touch otherwise and there an unquantified limit on this.  It gets pretty hot when the bid comes into question b/c some idiot technocrat can't see he is cutting his own balls off.


WhiteNight123129's picture

That reminds me of Paulson supposedly an arb fund who buys whatever hostile deal, up in the air corporate action, and takes leverage on the risk deals he books, introduce some external shock and his strategy blows up. I can see the logic of having a backstop but for how long? Arb is usually good when the shock occurs and no one touches the relationship, I guess when the idea of no trigger on CDS shocked the CDS arb guys, the one on teh sidelines made a killing (being on the sidelines pay-off specially when the other guys are chasing pennies with tons of leverage, they just make themselves vulnerable ot a shock. )

I do not know if ECB are idiots but from an historical standpoint, all currency unions failed except when the resulted in a new country (german principalities currency union ==> Prussia and American Colonies ===> USA with Hamilton, you guys are more versed than I am on that).

So the point is how do factor a chaotic event like Greece gets out in a hard default, run on the Southern European banks, Portugal gets out, spread gets totally out of wack, ISDA suspension of trading for a while? (that would not be unprecedented)

jm's picture

Everybody is picking up pennies even if you hold your money in 3M tbills because unpredictable, adverse things can blow anything up.  It's all relative.  That said, I respect the tail risk guys more than I did earlier this year, but I just don't see how you can make money that way over the long term.  You lose fortunes waiting and you are as often wrong as you are right.  And some guys just seem to have a magical gift to intuit and anticipate like Gundlach and Steinhardt.  Just amazing:  looks like art not science or craft.

I think that mean reversion works best given 3 sigma+ moves.  Moves like that are driven by external shocks-- like Fukushima.  What happens in between those outliers is random drift. Mean reversion happens when people determine it wasn't as bad as they thought it would be.

Regarding the backstops, I'm not necessarily saying how things ought to be, just how they are going to be.  A state can't stand by and see credit markets lock up for long.  The ham-handed way Trichet dealt with the situation (raising rates) and Merkozy inconsistency is just irrational. For a policymaker to ignore the needs of the majority of the EU just because Germans insist on kicking all of the EU including themselves in the balls is stupid. It is even more stupid when Germans insist they are going to get a hand-job even as the boot is about to meet crotch.   

ebworthen's picture



" This trade which buys bonds (optically improving the market's perception of reality)..."

Isn't this the problem with all swaps, and our markets in general?

Markets cease to be markets when speculation and leverage exceed capital formation.

Damned seven-tiered roulette wheel.

Ghordius's picture

"Unlimited" liqudity generates nearly "unlimited" speculation.

Nice, first you set fire to the house, then you sell fire insurance, then you short the insurer, then you buy up the insurer, then you sell water to the fireman, then...

...all thank you for saving your house and your insurance company

jabaykhan's picture

have reuters, not bbg. do they use z-spread in bbg for basis calc?

jm's picture

bbg gives you both z-spread and gross spread in the asset swap calculator. 

electricgorilla's picture

The scary thing for the ECB is when the decompression of the spread between the bonds and cds occur but the basis traders decide that its not worth it to capitalize. The ECB is lucky these traders were even willing to capture spread when Greece was on the brink.

There's a 1,000 pound Gorilla on the back of the ECB with a hundred more 1,000 pounders waiting in line to jump on board

Snakeeyes's picture

Here is my attempt at summarizing the European Debt Crisis in ONE MINUTE!!!!!!!! For presentation tonight at George Mason University.

Economic Minute Presentation on the European Financial Crisis - Low GDP Growth, Staggering Debt, Geithner On The Prowl In Europe!


Peter K's picture

As far as price action in the btp and spg is concerned over the last month or so, it appears to me like the ECB is taking down a lot more paper than is showing up on its books, as reported each Monday. Got a sneeking suspicion that they are parking some of the stuff somewhere, maybe at the EZ CB's (?), or maybe in a FED account (?) at the ECB.

Is it just me(:?

Market Efficiency Romantic's picture

trying to maintain the technocrats' credibility. Unfortunately well advertised, so there is a political arbitrage game playing out. That's so Soros 2.0, speculation against technocrat credibility. Only that in this game, the dealer also sits at the table - with an evil grin on his face.

And the game has long been lost for sovereigns. Allowing technically fester CDS quotes and unregulated player/dealers to determine sovereign debt prices puts sovereigns with >95% of chips on the table in a pretty poor position.

Snakeeyes's picture

For the short run. Here is my presentation tonight pdf that I will also be giving to Congress tomoirrow. NOT testimony, just an information session.

Economic Minute Presentation on the European Financial Crisis - Low GDP Growth, Staggering Debt, Geithner On The Prowl In Europe!