Risk Management

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CMA Now Officially Assumes 20% Recovery In Greek Default - Time To Change Sovereign Debt Risk Management Defaults?





One of the ironclad assumptions in CDS trading was that recovery assumptions, especially on sovereign bonds, would be 40% of par come hell or high water. This key variable, which drives various other downstream implied data points, was never really touched as most i) had never really experienced a freefall sovereign default and ii) 40% recovery on sovereign bonds seemed more than fair. Obviously with Greek bonds already trading in the 20s this assumption was substantially challenged, although the methodology for all intents and purposes remained at 40%. No more - according to CMA, the default recovery on Greece is now 20%. So how long before both this number is adjusted, before recovery assumptions for all sovereigns are adjusted lower, and before all existing risk model have to be scrapped and redone with this new assumption which would impact how trillions in cash is allocated across the board. Of course, none of this will happen - after all what happens in Greece stays in Greece. In fact since America can decouple from the outside world, it now also appears that Greece can decouple from within the Eurozone, even though it has to be in the eurozone for there to be a Eurozone. We may go as suggesting that the word of the year 2012 will be "decoupling", even though as everyone knows, decoupling does not exist: thank you 60 years of globalization, $100 trillion in cross-held debt, and a $1 quadrillion interlinked derivatives framework.

 
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Guest Post: It Ain't Over 'Til It's Over





If there is one lesson to be learned from the Japanese experience with deleveraging over the past few decades it’s that deleveraging cycles have there own special rhythm of reflationary and deflationary interludes.  Pretty simple thinking as balance sheet deleveraging by definition cannot be a short term process given the prior decades required to build up the leverage accumulated in any economic/financial system.  If deleveraging were a short term process, it would play out as a massive short term depression.  And clearly any central bank would act to disallow such an outcome, exactly has been the case not only in Japan over the last few decades, but now also in the US and the Eurozone.  We just need to remember that this is a dance.  There is an ebb and flow to the greater (generational) deleveraging cycle.  Just as leveraging up was not a linear process, neither will the process of deleveraging be linear.  Why bring this larger picture cycle rhythm up right now?  The recent price volatility we’ve seen in assets that can be characterized as offering purchasing power protection within the context of a global central banking community debasing currencies as their preferred method of reflation for now, specifically recent the price volatility of gold.

 
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Would A Ponzi By Any Other Name Smell As Bad?





The bond market has always had clever names for bonds in specific markets.  Eurobonds, Yankee bonds, Samurai bonds, and now, Ponzi bonds.  I’m not sure what else to call these new bonds, but Ponzi bonds seems as good as anything. NBG issued these bonds to themselves, got a Greek government guarantee (how can a country that can’t borrow, provide a guarantee?) and took these bonds to the ECB to get some financing.  The ECB won’t buy National Bank of Greece bonds directly, they won’t buy Hellenic Republic bonds in the primary market, but they will take these ponzi bonds as collateral?  Greece, and Italy, is sacrificing the people and the country for the good of the bank. The market had made some attempt to charge banks with bad risk management, awful assets, and opaque books, more than they charged the country they were domiciled in.  But rather than let the market (and common sense) rule, a mechanism to let banks fund themselves cheaper than the countries they rely on, was created. Asides from giving Ponzi a bad name (at least until the ECB just admits that they are printing faster than even Big Ben) this is tying the banks and the countries ever closer.  A long, long, time ago (1 month) it was conceivable that a bank could fail and the sovereign survive.  That is becoming less clear.

 
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Guest Post: The Road To Perdition – With Keith McCullough Of Hedgeye Risk Management





Over the next 3-6 months, US debt obligations will start maturing. Although the mainstream media is not yet focusing on the coming crisis, Keith McCullough from Hedgeye Risk Management and a contributor to Bloomberg says we need to prepare for the road to perdition. I caught up with Keith to discuss three hot topics for our Wall St. Cheat Sheet podcast: 1) The imminent US debt maturities; 2) Whether we can expect to repeat Japan’s lost decade(s); and, 3) What the Federal Reserve needs to do to set us back on the path to prosperity.

 
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Fed Vigilante Tom Hoenig Blasts ZIRP, Warns Market "To Cease Its Reliance On Fed Risk Management"





"There is no question that low interest rates stimulate the interest-sensitive sectors of the economy and can, if held there too long, distort the allocation of resources in the economy. Artificially low interest rates tend to promote consumer spending over saving and, over time, systematically affect investment decisions and the relative cost and allocation of capital within the economy... We now find ourselves with a Federal Reserve system balance sheet that is more than twice its size of two years ago. The federal funds rate is near zero and the expectation, as signaled by the FOMC, is that rats will remain so for an extended period. And the market appears to interpret the extended period as at least six months. Such actions, moreover, have the effect of encouraging investors to place bets that rely on the continuance of exceptionally easy monetary policy. I have no doubt that many on Wall Street are looking at this as a rare opportunity... The unintended negative consequences of such actions are real and severe and if the monetary authority goes too long in creating such conditions. Low rates over time systematically contribute to the buildup of financial imbalances by leading banks and investors to search for yield... The search for yield involves investing less-liquid assets and using short-term sources of funds to invest in long-term assets, which are necessarily riskier. Together, these forces lead banks and investors to take on additional risk, increase leverage, and in time bring in growing imbalances, perhaps a bubble and a financial collapse... While we may not know where the bubble will emerge, these conditions left unchanged will invite a credit boom and, inevitably, a bust. I am convinced that the time is right to put the market on notice that it must again manage its risk, be accountable for its actions, and cease its reliance on assurances that the Federal Reserve, not they, will manage the risks they must deal with in a market economy." - Kansas Fed President Thomas Hoenig

 
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