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Archive for the ‘Credit Default Swaps’ Category

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.

There has been much digital ink spilled on the Foreclosuregate (or if you prefer, Fraudclosuregate) story over the last couple of years, but one thing has been only touched upon lightly – if at all.

That is the underlying “low-level” fraud that is unspoken in many of these actions.

There’s a general principle under the law when one desires to bring a lawsuit – the principle of injury.  That is, you can’t sue me because you think I’m ugly.  You need to show actual economic damage in order to obtain the relief you seek.  There are many examples where civil courts have reached a conclusion that indeed the facts support the case but there’s been no showing of economic harm and thus the plaintiff gets awarded one penny.

There has been an astounding lack of credulity on this matter of economic injury in these foreclosure suits.  In fact, I’ve yet to see a foreclosure complaint that alleges actual economic injury.

Instead, they all allege it’s cousin, lack of payment.

But lack of payment isn’t necessarily economic injury.

Let’s say that you hit me in your car.  You have insurance and so do I.  My medical treatment costs $20,000, and you’re ruled entirely at fault in the collision.  We’ll assume for the moment I have no “pain and suffering” damages nor lost time at work and thus no lost income – that is, we have a neat and tidy case where the total economic harm is $20,000.  I cannot sue you unless my economic injuries are not paid for through some other means.

If your insurance company pays the medical bill, I no longer have economic harm, thus I cannot win anything in a lawsuit.  Likewise if my insurance company covers the bill (unless it jacks up my insurance rates or somehow otherwise damages me.)  Finally, you might just hand me $20,000, which moots my pending lawsuit immediately as once again, I have no economic harm.

When a mortgage loan is packaged into one of these “securities” and then all sorts of protection and credit enhancement are taken against it, it is no longer a simple matter of saying that because you didn’t pay, there are economic damages in the amount of your lack of payment.  In fact, there may be no economic damage sustained by the entity that is suing you at all!

Take the instance of a “credit default swap.”  Remember that a CDS is not an insurance contract.  That is, it typically will not contain things like a right of subrogation or set-aside (the ability to go after the cause(s) of the payment under the CDS contract or pursue other assets of the defaulter in court) but rather is a pure “payment for event” sort of agreement.  Well, if that CDS payment moots the economic damage, does the alleged foreclosing party still have standing to eject you from your house?

Let’s follow this through an MBS.  For simplicity sake we will assume it is comprised of 1,000 loans.  Let us further presume that 10% of those loans default.

Ok, can you foreclose on those homeowners?

Remember, to be able to sue for a remedy in civil court, you must show economic harm.  A breach without economic harm brings no right of recovery!  Being pissed off is not economic harm, and neither is non-payment unless the party suing you, directly or through an agent, suffers a loss.

Well, in the base case you’d probably say “yes”.  But who can sue?  Normally the PSA delegates this authority to the servicer or their agent.  Again, however, the underlying facts to be pled in a lawsuit that permit recovery must demonstrate economic harm.

The key question: Were the certificate holders economically harmed when all of the payment flows are accurately accounted for?

Well, that does depend now, doesn’t it?  The super-senior holders might not be, because of their credit protection.  More-junior holders might be harmed, but then the question turns on an accounting – was there credit protection bundled with the tranche or did they purchase it individually?  Was their position actually damaged as a consequence of your non-payment?

Hmmmm…. looks like we need an accounting here of the trust and the actual economic harm, right?  This does not mean, by the way, that one must show any particular amount of harm, beyond the general threshold of “materiality”, to sustain a foreclosure.

But what if there is no harm at all because of these credit enhancements and swaps, and in fact foreclosure is actually a double-dip – that is, double recovery?

In that case all such foreclosures are fraudulent.  Not because of a lack of paperwork and not because someone “should” or “should not” get a free house – but simply because the entity bringing the suit not only didn’t suffer a loss, they stand to gain rather than recover a loss through doing so.

Can I ask why we don’t see both pleadings where a securitized loan defaults alleging actual economic harm and an accounting of how that’s arrived at, rather than its surrogate – the allegation that you didn’t pay?

From the WSJ:

The latest infiltration was sophisticated in that it involved significant reconnaissance prior to the attack, and code written specifically to penetrate the IMF, said Tom Kellermann, a former cybersecurity specialist at the World Bank who has been tracking the incident.

“This isn’t malware you’ve seen before,” he said, making it that much more difficult to detect. The concern, Mr. Kellermann said, is that hackers designed their attack to gain market-moving insider information.

The attackers appeared to have broad access to IMF systems, which would give them visibility into IMF plans, particularly as it relates to bailing out the economies of countries on shaky financial footing, Mr. Kellermann said.

That could be a problem.

Apparently the IMF doesn’t seem to think that encrypting data in file stores is important.  It might now, of course, but it’s a bit late.

Now the question turns to who it was.  Was this a state-sponsored attack or was it the activity of what could be called “activists” who are interested in using this information either for profit or, more likely, as a means to either embarrass or even attempt to civilly detonate governments?

One has to wonder exactly what’s going on here with the recent ramp-up of these sorts of incidents.  The recent RSA token scandal was one that apparently had its roots planted several months ago and was hushed up.  These little ”two-factor” tokens are extremely secure provided the key-generation algorithm tied to their serial number is not compromised. But if it is then the token is literally worthless.

Why the IMF?  Well, that’s simple: There’s plenty worth stealing there, even though there shouldn’t be.  Rumors abound, of course – that the IMF entered into secret treaties (and “treaty-like” agreements) with various governments related to the Greek bailouts (and others), that there are certain hidden (and not-so-hidden) facts about who’s holding the risk on Greek debt in these discussions and more.

The latter, by the way, is interesting.  The “direct exposure” to a Greek, Irish or Portugese default is mostly in Europe, as you would expect.  But the indirect exposure via credit instruments, including those damned Credit Default Swaps, is substantially in the United States.

This is not a trivial amount of money either; we’re talking about, in aggregate, north of a trillion dollars.  Of that roughly $129 billion rests here in the United States in the form of these indirect and not clearly denoted obligations.

Guess what this means folks?  US Financial Institutions would have to make payments to European banks.  Once again we would be bailing out Europe for their idiocy.

When did this all happen?  Who’s been selling CDS against foreign debt, why, and where are the reserves, amounting to more than $120 billion, behind those sales?  That is not a small amount of money.

I have said this repeatedly since the crisis erupted: All credit instruments must be exchange traded, not “cleared” or “registered.”  This double-blinds the transaction and forces nightly posting of margin and identification of the risk that each party is holding.  It prevents “chained risk” and thus systemic risk.  And finally, it prevents hiding this sort of crap as the open interest on each contract is visible to everyone, every night, in public and everyone involved must prove capital sufficiency every night.

The solution to this problem remains as it was in 2007 when I started yelling about it: Force it all onto an exchange and for those who cannot post margin as they simply do not have the money declare the contracts fraudulently entered into and void. 

Dodd-Frank refused to address this.  Our government has refused to address this.  Now, four years on into the mess which was not fixed, we are seeing “Round #2″ and as the BIS data shows and John Mauldin has published, we are again being held hostage by a bunch of crooks who wrote “insurance” against risk without the money to pay.

It is time for Congress and the people to demand answers and stop this crap right now.  We, the people, must not pay off these bets in what is clearly an organized looting operation.

The Market-Ticker

Amazing….

BERLIN—Germany is considering dropping its push for an early rescheduling of Greek bonds in order to facilitate a new package of aid loans for Greece, according to people familiar with the matter.

Berlin’s concession that it must lend Greece more money, even without burden-sharing by bondholders in the short term, would help Europe overcome its impasse over Greece’s funding needs before the indebted country runs out of cash in mid-July.

What this really means is that Merkel has been apprised of the fact that her banks over there have written too many swaps and are too highly leveraged to survive a Greek default without yet another round of taxpayer funds from the Germans.  She is therefore willing to risk political suicide (which is almost-certain) in order to avoid having to admit that the game-playing has continued post the original Greek crisis, and that in fact there has been no de-leveraging or cleanup of the German (and French, incidentally) balance sheets at all.

In fact, what I suspect is that these banks over in the Eurozone have been buying up these Greek bonds at a nice discount and then tendering them to the ECB on a Repo basis for cash at full par value.  This of course is manifestly unsound but it’s what happens when nobody can see inside the “magic box.”  The problem comes if Greece suddenly decides not to pay, at which point the Repo transaction becomes uncovered and the ECB is screwed.

Euro-zone governments have ruled out lending to Greece without IMF participation. Greece will face a payment crisis in July unless it receives €12 billion of credits on June 29 from the IMF and Europe, euro-zone officials say.

I’ll lay even odds that Greece doesn’t have until June 29th.

Meanwhile Bloomberg says:

“There’s a degree of confidence that cooler heads will prevail and the next round of assistance will be forthcoming”for Greece, said Robert Rennie, chief currency strategist in Sydney at Westpac Banking Corp.

Cooler heads?  What’s “cool-headed” about giving an entity that has proved it cannot balance its budget more and more money on loan? 

Oh yeah, I get it – we can’t possibly let the truth out.  You know, the ugly truth: Greece is insolvent and so are a significant number of banks that lent it money while being levered up 30:1.

Yes, still levered 30:1.  You are over there in Europe, aren’t you?

Why I bet you are.

Of course there’s also a public charge of Treason that has now been leveled against the Greek Prime Minister too….

The gist of the allegations rest on the charge by Mr. Kammenos, that the Greek Prime Minister, Mr. George Papandreou and members of his team, presided over the sale of 1.3 billion dollars worth of credit default swap contracts (CDS on Greek sovereign debt) on or around December of 2009, shortly after coming to power. The 1.3 billion dollars worth of insurance protecting against a Greek default was bought during the spring and summer of the same year, by the Hellenic Postbank, a public banking arm of the Greek government.

Oh that’s very nice.  Isn’t that kinda like our Fed writing credit derivatives?  They haven’t done that, right?  That would be illegal, right?  Oh wait, they have done that…

Oh boy……

The Market-Ticker