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Archive for the ‘Credit Default Swaps’ Category

Hmmm…. I was asked about this in an interview yesterday (it’ll be published in the next few days) and thought it was worthy of a Ticker comment as well:

Washington, DC—At the request of CME Clearing Europe Limited (CMECEL), pursuant to Section 7 of the Commodity Exchange Act, the Commodity Futures Trading Commission issued an Order on March 13, 2012, vacating the registration of CMECEL as a derivatives clearing organization.

The Order of Vacation is available on the CFTC’s website (see Related Links).

Why?

Well, the firm did ask — they didn’t get thrown out, they walked off.

One can only surmise that they have detected a potential problem that they don’t want to be a part of.  Might it be a question of whether the CDS on European debt have any sort of actual margin against them, and if not, whether they might get “urged” (or worse) to backstop those bets?

I suspect so.  I further believe, as I’ve repeatedly noted, that the European banking system is dramatically over-levered and no attempt has been made at all to take that leverage down.  This was remarkably stupid prior to 2007 but now is into the realm of criminally stupid, not that anyone seems to care from a regulatory point of view in the EU.  A good part of the reason for that willful blindness is simply the structural flows from Germany (in particular) to the periphery — in short the entire European “experiment” is predicated on continuing to hide the transfer of wealth from German citizens to the periphery who cannot afford the goods exported from Germany to their nations.

If and when the Germans decide they’ve had enough of this crap — or the rest of the PIIS decide to say “since Greece got to pay half, we demand equal treatment or you’ll get nothing” the game will truly be over — and that blowup is likely come with little or no warning. Now add to that backdrop the oft-repeated CME claim (right up until MF Global blew up) that no customer of a CME firm had ever lost a nickel of segregated funds and you’ve got the making of a real mess.  The system survived the first “dislocation in the farce” but would it survive another?

Probably not.

This move by the CME thus looks to be defensive — and well-founded.

In this morning’s Cashin’s Comments, UBS’s Art  Cashin addresses what worries traders these days.

A Greek default has been on everyone’s minds lately.  But the traders  Cashin has talked to think that it’s just the tip of the iceberg.

The bigger fear is what happens in the credit default swap (CDS)  markets.  No one knows how big it is, who the counterparties are, and,  worst of all, whether the CDS contracts will actually trigger in what many would  consider a default.

Here’s an excerpt from Cashin’s note:

Is There More At Risk Than Greece In A  Greek Default – Recently, there has been a buzz building on trading  desks and trading floors that there may be a lot more at stake in a potential  Greek default than the media has been talking about.

As of now, most of the public discussion has  centered on potential contagion among the banks as most of the Greek sovereign  debit is held by the European banking community.

Traders, however, fear that the real risk is in  the area of credit default swaps (CDS).  They are insurance policies,  individually written, that basically say – if Greece defaults, we’ll pay you  what they should have.

Credit default swaps have grown exponentially  over the last decade.  Since they are individually written, there  is no clear visible record of how many CDS contracts are outstanding.  Also  unknown is who is involved.  The two parties obviously know who the  counter-party is but there is no public record that would allow a regulator or a  third party to find out who was involved. … No  one knows how much CDS exposure there is on Greek debt but is assumed to be a  lot.  Banks and others looked at the very high and attractive yields  on Greek bonds and began salivating.  But, what about that risk  – better buy some insurance. … Recall that, months ago, negotiators on the  Greek debt bumped into part of the CDS problem.  If the holders agreed to  take 50 cents on the dollar, would that trigger their CDS on that bond (paying  them the conceded 50 cents and making them whole).

At that  time, many contended that if the bondholder “accepted” the offer of 50 cents on  the dollar, that made the event voluntary and it would not “trigger” the CDS  payout.  That caused lots of folks to ask for a ruling from the ISDA (the  ruling group on CDS contracts).  If you “accepted” an offer with a gun to  your head, was it really voluntary? … But, traders fear a worse  outcome might occur if the CDS contracts do not kick in.  What  good is insurance that doesn’t pay off.  That could lead to the assumption  that all CDS insurance was useless.  That would stratify debt around the  globe.  Great credits could get all the money they wanted, but less than  great credit would be shut out because it could not be insured.  That could  make the future one in which “the haves” will have whatever they want and all  others nothing.  Welcome back to the Middle Ages.

Business Insider

A default by any other name is still a default. When Greece defaults, the  inter-connected chains of credit default swaps will fall like dominoes.

For your Superbowl half-time reading, here is a brief summary of the situation in Europe:

1. Greece is poised to default, the end-game everyone anticipated in 2011. It is not a matter of if but when.

2. That default will trigger credit-default swap contracts, derivatives known as CDS that protect the owner from events such as default.

3. This will implode the shadow-banking system and the visible banking system, as those who sold the CDS (financial institutions) do not have enough cash or assets to pay the owners of the CDS.

4. The general idea is that sovereign default is very unlikely, so you can sell protection (CDS) against that possibility for a low premium, and cover that bet by buying your own protection from another player.

5. If that player (counterparty) can’t pay you off, then you can’t meet your obligations on the CDS you originated and sold.

6. So the failure of one counterparty can trigger a systemic failure akin to a row of dominoes being toppled by the fall of one domino.

7. To avoid such a CDS-triggered collapse, the European Union and its proxy agencies (European Central Bank, etc.) are attempting to call a default by Greece something other than “default.”

8. This will theoretically keep the first domino–a credit-default swap–from falling.  In other words, if we call a default by some other name, then it isn’t a default.

9.  Those absorbing the losses caused by a Greek default (and let’s stipulate that this references owners of Greek debt who bought CDS as insurance, not speculators who leveraged CDS at 30X the actual bond value) will want to cash in their insurance, i.e.  the CDS they own against a Greek default. They have every incentive to demand a default be  recognized as a default. If they accept the official plan to avoid calling a default a default, then all the losses will be theirs and none will fall to the counterparties who sold them  the CDS.

10. How is this fair?

11. The official response of avoiding default is focused on self-preservation, not fairness, justice or the rule of law.

12. The system can be likened to a pool of $100 bets leveraged off $5 in cash. If every bet is covered perfectly, then it’s somewhat like $95 in bets being paid by passing $5 around–much like the famous email that depicts all debts in a small town being paid by the same $5.

13. In the real world, somebody’s bets and insurance will not be perfect and their obligations will exceed their cash on hand. In other words, they will end up with $3 and owe $5. They will default and the dominoes will start falling as everyone down the line doesn’t receive their $5 counterparty payoff.

14. Empires tend to fall when the interests of their Elites diverge.  We are at such a point in the global financial Empire.

15. “Extend and pretend” has “worked” for almost 2 years. If Greece defaults and it is recognized by even one player as a default, then the system will quickly unravel and cash/dollars will be king until the deleveraging runs its course.

Charles Hugh Smith – Of Two Minds

European finance ministers and politicians have come to the conclusion that a deal, even one involving a credit event, is better than no deal at all. Thus it is increasingly likely the Greek Debt Wranglewill trigger credit default swaps.

Opposition to payouts on Greek credit-default swaps from European Union policy makers is softening as disputes over a voluntary debt exchange threaten to push the nation into default.

Any agreement between the Greek government and the Washington-based Institute of International Finance on debt writedowns will only bind 50 percent of investors in the 206 billion euros ($270 billion) of notes being negotiated, Barclays Capital estimates. Hedge funds may resist a deal, seeking to get paid in full or compensated from insurance contracts

“Politicians seem less concerned than before about CDS triggers,” said Michael Hampden-Turner, a credit strategist at Citigroup Inc. in London. “Having a payout on Greek CDS is probably better than the alternative: a loss in market faith of the product’s ability to provide a hedge against sovereign risk.”

Officials, including former European Central Bank President Jean-Claude Trichet, have insisted that a swaps trigger was unacceptable because traders would be encouraged to bet against indebted nations and worsen the crisis.

Greece said it may impose losses on investors who fail to support the debt restructuring by adding a so-called collective action clause, or CAC, into its bond documentation. That would force holdouts to accept the same terms as the majority.

Use of CACs would trigger a restructuring credit event and a payout of default swaps, according to rules from the International Swaps & Derivatives Association.

“A CAC is looking increasingly like the best option,” Citigroup’s Hampden-Turner said. “That route seems to tick a lot of boxes: they don’t have a bond default, the official sector gets treated differently than the private sector, and everybody has to participate in the exchange without anybody getting paid in full.”

ECB Opposition

While the ECB oppose any involuntary restructuring of Greek debt, policy makers such as Dutch Finance Minister Jan Kees de Jager say they aren’t against a credit event.
The softer stance signals Greece is unlikely to get sufficient participation in a voluntary bond swap to make its debt burden sustainable.

The ECB is now alone in its opposition to a credit event. Then again, the ECB alone was against haircuts, soft defaults etc.

As late as May 7, 2011 former ECB president Jean-Claude Trichet insisted there would be “no Greek debt restructuring”. I wrote about it in Trichet Reiterates Restructuring “Not on the Agenda”, Market Reiterates “Trichet is a Pompous Fool”.

Since then there have been two restructurings, and we are now headed for an involuntary restructuring that will trigger credit default swaps.

I suspect an effort will be made to placate the ECB somewhat so that the ECB does not take a loss on the 40 billion euros of Greek debt it stupidly bought, but otherwise, the ECB is about to have this crammed down their throats.

Portugal waits on deck.
Mike  “Mish”  Shedlock – Global Economic Analysis

There’s really not much more to say than this….

Value	1,577.42
Change	593.840 (60.375%)
Open	1,577.42
High	1,577.42
Low	1,577.42

Source: Bloomberg (click link above)

No, that’s not a stock.  It’s the CDS spreads on the PIIGS (composite), and is up an astounding 60% today.

It’s over folks, despite the protests of BNP, which reacted in predictable fashion to a WSJ “opinion piece” this morning:

‘We can no longer borrow dollars. U.S. money-market funds are not lending to us anymore,” a bank executive for BNP Paribas, who declines to be named, told me last week. “Since we don’t have access to dollars anymore, we’re creating a market in euros. This is a first. . . . We hope it will work, otherwise the downward spiral will be hell. We will no longer be trusted at all and no one will lend to us anymore.”

The bank denied it, of course, and the source “declines” to be named.

So what’s the truth?

It’s simple: We’re all Greece.

There’s no material hiring going on in the US, nor will there be.  Not because business wouldn’t like to hire, but because there’s no organic demand with which to require the hiring to take place. As a former CEO I can tell you that hiring is a dispassionate decision: You hire staff to produce the goods or services you sell – and for no other reason.

The Government took upon itself to create false economic demand after 2008 through deficit spending.  Private business knows this cannot continue forever, or you get Greece.  It’s not really very complicated; try using your credit card to maintain a $173,000 lifestyle when you only make $100,000 and see for how long you’re able to do it.  That’s what our Government has sequentially done for three years running from 2008-2011.

Every businessperson with an IQ larger than their shoe size knows that this path forward will – because it mathematically must – fail.  They were willing to accept a short-term incidence of this back in 2008, because that’s exactly what they believed it would be – a very short-term phenomena.

But now, in 2011, it’s clear that it isn’t a short-term phenomena.  And as a consequence there is no hiring going on, because this Ponzi must end, and when it does these businessowners know the outcome will be horrific.  They do not intend to get caught not under the falling knife, but the falling grand piano.

The President and the Republican candidates can claim to have “plans” or want “stimulus” or whatever.  The fact is that none of this will work.  It will not work because the claims of “deleveraging” and “balance sheet repair by consumers and households” is a lie.

Source: Federal Reserve Z1

De-leveraging and balance sheet repair?  Where?  Total consumer and mortgage indebtedness is only back to 2007 levels (when we hit the wall and we had a much-lower unemployment rate.)

The often-repeated claim that balance sheets at the consumer level have been “repaired” is a bald lie, repeated nearly daily in the media, in an outrageous and puerile attempt to goad both consumers and businesses into taking economically unsound steps.

This strategy of lie, lie and then lie some more has failed.

The only actual fix is to truthfully de-lever.  This means not supporting the bankrupt, other than shepherding them through the courthouse door where their bankruptcy proceedings are heard.  It may mean some sort of expedited process for bankruptcy, which I’ve advocated for quite a long while.

We need to remove one half of the total credit market debt in the system in the United States alone.  There are only two ways to do it – default and/or pay it down, or grow fast enough without taking on any more credit that the percentage of GDP represented by debt declines.

The latter is not going to happen because the entire last 30 years of our so-called “growth” was a Ponzi built upon more and more debt everywhere.  Yes, during Clinton, yes, during Bush (pick a Bush), yes, during Reagan.

This is the truth whether you wish to hear it or not.  Whether you wish to face it or not. And until we as a nation and the world as a whole stop playing pyramid games with debt there will be no actual and functional recovery.

We used currencies, offshoring and other means of market manipulation to cover up that which could not work on a sustainable forward basis.  We built the pyramid ever-higher, driving asset prices to the moon, and yet none of these “asset price” gains were real and underpinned by actual returned cash earnings.

The check is on the table folks. Europe was just as profligate as we were, and their banks were just as immature in their “analysis” before buying up debt – that is, lending people money who had no prayer in hell of ever paying it back.

This is the same game that was run in the 1980s, the 1990s with the Internet bubble, and then in the housing bubble in the 2000s.

In the 1990s when I ran MCSNet the claim of “trees grow to the moon” was predicated on the Internet doubling in size every three months.  This was true for about a six month period immediately following the introduction of Windows 95, which was the singular event that brought Internet access to the mass-market.

From that point onward it was a knowing and intentional lie.

Yes, penetration continued to grow and yes, the network continued to expand, but the explosive doubling pattern happened on the original “uptake” and then ended.  It had to, because if it had not every bacterium on the planet would have had internet access within a bit more than a decade.  This, again, is mathematics.

There were literally thousands if not tens of thousands of people who had access to the core routing tables and data flow rates that knew the claims being made were lies, myself among them.  Sure, as the type of data being moved went from plain text (Gopher and embryonic HTTP) to images to sound-and-graphics and then full-motion video the data requirements continued to grow but the fanciful claims of doubling every three months simply couldn’t have gone on for more than a couple of years because the following is what would have happened:

2
4
8
16 < End of first year
32
64
128
256 < End of second year
512
1,024
2,048
4,096 < End of third year (!)
8,192
16,384
32,768
65,536 < End of fourth year (!)
…..
4,294,967,296 < End of eighth year (!!!!!)

Incidentally, that last figure is approximately (within one additional three-month period) the number of people on the planet.

This is the problem with exponential (compound) growth.  It’s inherently a pyramid scheme and inherently must, at some point, end.  It must end because eventually you run out of ability to sustain it – you run out of suckers and the pyramid collapses.

This always happens because it mathematically must happen.

When debt grows faster than output on a compound basis the two curves inevitably run away from one another and must always result in a collapse.

This is not a political issue, it is not a left or right issue, it is a function of simple mathematics.  Those who were IPOing these businesses in the 1990s and who were building and selling houses into the ramp in the 2000s were simply believing that they would unload the bag on you before the leverage pyramid in that particular part of the economy fell over.

That’s all the last thirty years was folks, and now we’re desperately scrambling on a global basis to find just one more sucker.  To obtain just one more hit off the crack pipe.  To stave off death just one more day and draw one more breath.

Can we pull that off/  Maybe, for today.  Maybe, for tomorrow.

But on a forward, sustainable basis?

There the math is clear and so is the answer: NO.