That's very oversimplified, as is most of the mass media on credit default swaps. While people harp on swaps being unregulated, the legal framework surrounding swaps is actually pretty solid. Most are collaterallized, with collateral moving on a daily or weekly basis. Furthermore, when a credit event (like a bankruptcy) happens, there is a pretty well refined auction process that takes place. There have been about a half dozen auctions in the last two months, with several more scheduled between now and Thanksgiving. This is significantly more activity than we saw in the last two years combined. To this point, auctions have settled without real issues.

This is not to say there aren't real risks with CDS. There are. One of the things that article doesn't even mention, and which is a much bigger issue in the Lehman bankruptcy than the triggering of CDS payments on Lehman itself, is counterparty risk. You trade swaps with broker dealers, so when a credit event happens, you seek payment from your counterparty. Lehman was one of the biggest swap counterparties. So, by filing for bankruptcy, they default on all of their open swap transactions. The hope is that they run a matched book--essentially serving as the house in these trades, matching exposures on each side. But, the real issue in the lack of regulation is that you have no transparency into how well a broker has matched its book. Now, in the Lehman situation, you have tons of people who are owed by Lehman on terminated swaps, and tons of people who owe Lehman. The problem is the ones who owe Lehman aren't going to pay a bankrupt entity without being asked to do so by the bankruptcy court, and Lehman isn't paying those who it owes. At the very least, you have a massive delay in settling up--not as a result of the scary CDS transaction, but because the intermediary in the transaction went belly up.

From the "Very Obvious" Files: Mortgage Plan May Irk Those It Doesn’t Help - NYTimes.com


I love the final part.

Fair enough, and I appreciate the rest of what you wrote, but the bottom-line, to me, is that it seems that a lot of the actors here played fast-and-loose if not with regulations, than at least with common sense. There's a level of unreality here that I feel shouldn't really exist in financial systems.

Just wanted to give an update on the situation for Ms.path -- she is going to be able to switch to another position in her company. We're going to take a 20% salary hit which will take all the cushion out of our budget, but we'll be able to tighten our belts and get my stepson through his last 20 months of college barring any unforseen circumstances and then things should improve once that's done.

Thanks to all for the good wishes.

Libor's coming down.

Come on now, you don't get $60 trillion of exposure on $6 trillion of real financial instruments without some massive gaming.

Here is a little homework for someone trying to understand the modern financials market... research credit default swap exposure and compare it to stock price/bailouts of these finance firms (and insurers like AIG hint hint). I have not lost on a single short I placed on some of the worst offenders by that metric.

$60 trillion exposure on $6 trillion works IF AND ONLY IF the market is under constant expansion. Besides basic theory, which says that doesn't make sense, the entire idea of a credit default swap is that it is indeed possible that such a situation can occur, therefore necessitating trading away some of your bond profit for the 'insurance'.

Heck even the term of a 'matched book' makes CDS sound just like your average sports betting bookie operation.

Common sense says that with a giant downturn and credit freeze, that defaults can happen... and if the defaults trigger insurance that the bookies cannot cover, well we're going to see some more choking in the financials. I personally think we should get to root assets and shore them up, to avoid the low level defaults that lead to bank defaults that lead to CDS being called in... right now the government seems mostly interested in avoiding bank defaults (a valid concern, their tactics suck and can easily be undone by bad behavior from the banks being bailed or those stable banks getting greedy).

I think we need to let a large number of these contacts fail, there is just too much, and the penalty will fall on all sides (wiping out those selling insurance they can't provide completely, and those buying insurance will have to absorb the full loss of their bond default, and the fees).

Meanwhile, buy cheap oil! I can't fathom the sub-70 price, anyone know what the story the talking heads are giving for it is? (not enough time to sniff CNBC lately :( )

Wife just got laid off. Yay!

:( Sorry dude

Ouch. Sorry to hear that.

Global demand drop, global recession, speculation drove the price up, a future of years where alternative energy gets a drive to innovate, an impetus to drill domestically....etc.

sorry dude.

Thanks guys. Yeah, two weeks before her Christmas bonus which should have bought our whole present list. Well, at least she got two weeks pay and three recommendation letters. Still sucks.

Of course there is some speculation going on, but there is also a lot of very sophisticated credit risk management, transaction cost management and exposure management going on.

The $60 trillion number is somewhat misleading, because it double counts matching exposures. For example, if I've sold protection on a name, but hedged by buying protection on the same name from someone else, that is going to go down as two swaps and count into your aggregate number.

One of the problems we've noted a number of times is the lack of transparency, so it is difficult to gauge what an accurate number is for the real swaps "problem." However, the Lehman example may provide some guidance. It is estimated that there was several hundred billion in CDS written on Lehman itself (bets that Lehman would go bankrupt or hit some other credit event), however because a number of those trades were offsetting the actual dollars that changed hands in the CDS market as a result of the bankruptcy was just a fraction of that several hundred billion dollar number. And that's with the firesale price of about 8.5 cents on the dollar attained in the Lehman CDS auction (this means that those who sold protection would make up 91.5 cents on the dollar to the buyer of protection).


Couple things here. First financials have taken a beating all around. You could also correlate mortgage backed holdings to stock price of banks. Unless you shorted Goldman the day before Buffet's investment, you likely haven't lost a single short on a financial in general.

Second, many view swap spreads as a very useful tool in judging the health of a company. If a swap spread widens (meaning protection sellers are charging more to take credit risk with regard to a company), it generally signals that the company is in trouble and this is generally inversely proportional to the stock price.

Third, AIG is a bit of a special case here. They are not a broker dealer matching their books. They are an insurance company, so they generally landed only on the side of the trade selling protection. They had very few offsetting trades and the market downturns were that much more crushing to them. They also got into a bit of trouble because they had written protection contracts for CDOs (collateral debt obligations) that held mainly mortgage backed securities. Big time trouble.


I've got to be honest, I don't completely follow you here. While of course there was and is speculation going on in the swaps market, there is also a ton of risk management and hedging going on. Swaps price risk. Plain and simple. In theory, they work in either case. In an expanding economy, the protection seller "wins" because he never has to make the contingent payment associated with the default. In a downturn, the protection buyer has his insurance policy, but if the swap has been priced correctly, the seller has been fairly compensated along the way for ultimately bearing the brunt of the default.


Not a bad analogy. Broker dealers serve as an intermediary and make money off the bid-ask spread of the swap. If they've done a good job matching their book, they make a tidy sum.


Yes, counterparty risk, as we saw with Lehman, is the elephant in the room. However, it is not what the media has focused upon. Instead the focus has been on the fact that these are "bets" on whether companies fail? Big effing deal. The real risk is the intermediary failing. If you read Buffet's quotes on swaps from several years ago, this is what he was warning about and Lehman is the perfect example of this.

The swaps written on Lehman Brothers have settled in a pretty quiet way. That's done. Auction on October 10th, settlement last week. What isn't done is settling trades that were terminated because of Lehman's default. This is what I mentioned in my earlier post. You have counterparties who owe Lehman on swaps and you have counterparties that Lehman owes. It is going to take more than a year for the bankruptcy court to sort out who owes Lehman what and make those folks pay and distribute proceeds to those Lehman owes.

That is why you are reading about the need to set up an exchange for swaps trading, much like the futures exchanges in place today. This would greatly reduce the counterparty risk, as you would not be dependent on an intermediary to settle your trade. I am skeptical of this happening any time in the near future.


Again, I don't see individual names defaulting as being a major shock to the CDS market. CDS are marked to market, and collateral is moved on a daily or weekly basis. Auctions are held and triggered swaps are settled. I went back and looked it up, and since the beginning of October, there have been 7 CDS auction protocols for CDS names that hit triggers. That's more than in all of 2006 and 2007 combined. There are an additional 4 scheduled in the next few weeks. Those auctions haven't really disrupted the market and all resulting transactions settled efficiently.

The ISDA protocols are pretty developed in their operation in the face of an individual name default. The ISDA agreements are also pretty smooth in how they handle these. The first big one in October were the Fannie and Freddie bail outs. I went to work that Monday dreading the pending credit event. I spent a total of about half an hour on the whole thing. Very smooth process. And again because of the pricing and collateral movement, most losses on individual names are mostly absorbed by the time of the default.

As I said above, the bigger issue in my mind is counterparty risk. That is why the banks and brokers are looked upon with a little more care. When the intermediary goes away, everyone pays (either in time or money (or both)).

Swaps are an easy target right now because people don't understand them. Has speculation on companies downfall contributed to some of the market panic? Of course. Should there be more transparency in the CDS market? Probably. Would an exchange help? Definitely. Is banning swaps the answer? Definitely not.


Not a commodities guy, but BUY! BUY! BUY!

Ugh...that sucks. All my best.

I do not what the source of this is or who Horowitz is but stories like continues to confirm my belief that the federal govt should not be in the charity business - but many people are still willing to give them more power and funds to do more things like is (esp. for other industries). Fools.

$50 billion of bailout going to employee bonuses

Posted Oct 31 2008, 07:30 AM by Andrew Horowitz
Rating:
Filed under: Merrill Lynch, Morgan Stanley, Goldman Sachs, banking, Andrew Horowitz

As if the economic bailout by U.S. taxpayers isn't enough to make you sick to your stomach, new information has come to light that several banks are planning to pay billions of dollars in year-end bonuses from the bailout funds they received. Investigations are beginning into the nine banks that took in the first $125 billion -- the same $125 billion that was supposed to be used to unclog the credit system which was preventing banks from providing much needed funds for individuals and businesses.
There are many feathers in a ruffle over this and New York Attorney General Andrew Cuomo and several congressmen are furious that over $20 billion has already been earmarked as bonus funds for management and employees. Unbelievably, that is just the estimates from Goldman Sachs, Morgan Stanley and Merrill Lynch. There are six more banks that are also working on similar heists.
Here is their rationale for using that money: It is reported that the financial industry pays base salaries in the range of $80,000 to $600,000 and apparently that is simply not enough to keep some of the best and brightest working to keep their companies profitable. It seems that if they were paid only this meager amount, the company would risk mass defections. That would be a real problem...or would it?
Maybe it is time to peg annual bonuses to something meaningful like profitability. As I recall, not only are these the firms that have been losing money (as is evident by the need for a massive multi-billion dollar bailout) but they have also been shown to be the creators of securitization, derivatives, sub-prime mortgages and other toxic credit that is the root cause of this historic global economic catastrophe!
Maybe I am being too harsh? Perhaps management is entitled to hundreds of millions in bonuses for the hard work they do, day in and day out. You have to feel sorry for them as most have had to give up their private jets and instead fly in a cramped seat in first class. Surely most will now have to wonder how they will deal with the excess workload as they have had to fire thousands of employees. Also, they will need to use a good chunk of that money to rebuild their retirement plans as much of their wealth was tied up in their company's stock which, under their leadership, could be down more than 60% just this year alone.

I agree that this is an outrage but I also believe that the payouts will not occur.

Are they really the best and brightest if they are the ones who created this mess?

Sorry :(

SI

the answer is "no".

The Iraq war was a more efficient use of government resources than this disaster. And we haven't even started feeling the effects.

Except for the 4000 deaths, I'd agree. If we're just talking dollar numbers, then you're absolutely correct. At least we're eventually going to get oil out of Iraq. At this point I'd say a lof of the $750 billion is going to disappear into the ether.

Agreed, the deaths and impact on families and foreign relations in general push the "total balance" in the other direction in terms of failures. But in terms of money, at least it was a boom to the defense industry and employed a lot of people.

I could think of at least 3 ways to use that money that would have a much better impact to the economy:

1. Build Nuke Plants/Upgrade Energy grid - employ people while migrating towards energy independance. What a concept. As a side effect, you may just "inspire" car manufacturers to build electric cars which can run on that nice, new, clean(relatively speaking) grid. More jobs and energy independance=stimulated economy=stronger dollar=stable housing market.

2. Pay Seller Credits - Devil is in the details, but I've preached it before that this will allow for graduality in the housing market and allow for people to move down (and up) to homes that are more affordable while helping to even out house values with each sale.

3. Have a "Brewster's Billions" lottery - If I won, I would spend, spend, spend. So in essence, I would create liquidity and stimulus everywhere I go. Oh wait...did Paulson win that? Damn...never bought mine.

digamma, my position might be related to the lack of transparency in CDS, but here is my concern.

The main intent of credit default swaps is to set up hedges... an area I am well aware of and support. More tools to manage risk the merrier in my opinion.

My concern though is that it has literally become a betting game where the exposure is not being reduced in all cases, but instead you may have firms using it as another way to make huge money with their huge leverage.

For instance, if you only sell insurance, and that is all your firm does, that is not really a hedged position, it is all a bet on the market going one way (up). I'm curious as to how many firms have done just that.

Already they have shown they don't do their homework when it comes to buying mortgage backed securities they DO NOT UNDERSTAND... now I'm nervous they have set up insurance with places that are not stable to provide it, and of course what happens when that falls through. So far you are saying it is going smoothly, so maybe its not a big deal... but I don't think the risk is being managed by CDS if the portfolio is about 10 times the size of the economy it is hedging. I could understand maybe 2-3 times... but to me it seems like the same thing as a mortgage company having 30 to 1 leverage, it is doomed on a downswing.

I guess you are right, shorting just about any financial has been good lately... so I guess look at bailouts/crashes and cds exposure. Lehman, Bear Sterns, AIG are some examples. There have been some foreign meltdowns, so looking at them might be even more informative (I have not as of yet, but I got a hunch).

It does seem that an insurance instrument being used for speculation is the kind of thing that should be regulated against.

The thing I'm saying is that the bigger concern now is not in individual name CDS. It is in counterparty risk. People who traded CDS on Lehman Brothers have settled and are done with the issue. People who traded CDS with Lehman Brothers have a long fight ahead of them to recover anything owed to them.

Lack of transparency does play a role because you want to try to diligence the strength of your counterparty. Because of the lack of transparency, that becomes very difficult.

Sorry GrantDawg. Mine just spent the summer in the same boat.

Maybe I'm naive, but I think McCain could have gotten a lot of points out of saying "fuck the bailout, the taxpayers are going to get raped here!"

Of course, he voted for it anyways. Schmuck.

Probably will be a lot of talk of the 5% drop in the DOW today, but one reason I keep whining to avoid spot prices... even with the drop we are still well over the two week low. Does 500 points come off the board because of Obama, or because it was put on the board to begin with the week before the election and its time for profit taking?

In other news, oil still sucks, but I ironically decided to directly play futures for the first time the day before the election (most of my oil speculation occurs through indirect means in the past). I hate the thought of owning barrels and barrels of crude oil, so I was fully intending to offload it on any uptick.

Yesterday I come back from voting and see I made 8% in a day (before my auto-transaction was triggered). Wacky damn economy! BTW oil futures are back down of course a mere day later.

So I'm just making all this noise because I get annoyed by all the market pundits in the media who seem to be feeding this mad speculative market with all the crazy excuses they have for a one day 5% DOW drop. You would think they would just admit they don't know poo and are talking out their ass (actually nevermind, they KNOW they are speaking shit).

Anyhoo, curious about other's thoughts about how Obama election (or house elections) will impact the economy in the long term.

It means nothing more than what it is. Just like when it tanked when the first bailout attempt failed, and then took a dive when the real bailout finally was passed. Did that mean they were unhappy the first one failed and also unhappy when the other one passed?

You think things are bad now. Wait until the Commercial Credit Crisis begins in earnest, when all the loans on heavily leveraged buyouts start tanking...it will make the Mortgage Crisis fiasco look like kids' stuff.

The people on Wall Street aren't stoopid. If they think Obama's policies will negatively affect business, they'll move capital into other investments.

What we're seeing now is just the continued volatility of the past few months. However by March, April of next year, Wall Street should have a decent read on where Obama is going and will react accordingly.

They're just waiting on the official naming of his intended economic team. They won't have to wait until March or April to know where he is leaning, they will have a good idea when those names come out.

Yes, I agree his economic team selections will influence the market a bit, but I think they will still wait to see whether Obama intends to govern as the centrist he ran as, or slides radically to the left.

People will use the results for whatever spin they subscribe to. When it tanked after the bailout failed, we heard "this will keep happening until you pass it". Then they pass it, more tanking, and that's "just what it is".

I have no doubt that if the stock market was up 800 points in the last few days, the election result would be credited as the reason.

Ouch. Talk about the Ogre's choice.

The Demos are trying to get the auto makers bailed out (again) before the next session comes in, and promising if it gets stalled till then, they'll make it their first priority come January.

I've seen folks urge against it, saying that the auto industry is too deep in the red, and we might as well let them fail naturally. The problem is, that approximately 1 in 10 folks would be out of work if we let them die, through direct layoffs, the knock on effects on the credit market, etcetera.

Die fast, or die slow, is the situation right now.

Why bail them out? Let's take our lumps now, however big, bad, and horrible they end up being. Putting bad companies like those on life support is merely going to delay the inevitable. It isn't like they have some terrific strategy and plan, and just need the money to make it happen. They have no plan beyond begging for some money.

I was very surprised when I moved to America to realise that in many ways the country is far more socialist than England.

There are far more market restrictions over here than back home, for instance the propping up of companies which are obviously non-competitive (compared to England letting our car, steel, coal industries collapse in similar situations) and the frankly shocking protectionist situation with some other industries (e.g. you don't allow ANY non-American banks into the country ).

This sort of thing is almost begging for a wastage of resources and inefficient market structure imho (such as the way your banks are setup to discourage saving and charge customers what in most other countries would be unreasonable amounts for basic services).

FWIW, I can understand the push to help the automakers. Im not sure how I feel about it although the speculation of 1 in 10 people losing their jobs if they should fail is a bit scary.

HOWEVER, I say fuck AMEX. they and their cohorts went out of their way to screw the consumer in the push to change the bankruptcy law and now that the consumer is squeezed and cant pay them, they have som 'bad debt' on their books and want help. I say fuck you to Amex.

Where does that number come from? I'm not saying that you are wrong, but it seems absurdly high to me.

What we need is the Alpha Bailout. Let the gov give every eligible taxpayer $500K. That way we can all pay off our mortgages, loans, bad debts, etc., etc., etc. People could save what they don't use, and it probably wouldn't cost the government much more than what they've paid bailing out the mortgage, insurance, banking, and (more than likely) the auto industry. :popcorn:

The actual number of jobs lost for the auto industry is 2.5 million jobs, which doesn't reach 10%. I'm guessing that 10% number may be a situation where all of the industries that supply the auto industry that may be affected are included in the total jobs lost.

200 000 000 * 500 000 = 100,000,000,000,000

Looks good!

We'll just print up more money to cover it!

Well, I guess this should alleviate some concerns on government buying bad assets. Not sure how they can change it on the fly, haven't we already bought a bunch of troubled assets?

Paulson: Troubled assets won't be purchased - Economy in Turmoil

yeah, the 1 in 10 is a knock on effect.

http://detnews.com/apps/pbcs.dll/art...TO01/811030343

The importance of the auto sector will be underscored this week when the Center for Automotive Research plans to release a new analysis of the impact on the economy if operations cease at any of the Big Three. McAlinden said the resulting drop in tax income and other losses over three years would far exceed the amount being sought in government aid. When the jobs tied to everything from buying a car to washing it and refining the gas that fuels it are added to the total, more than 14 million U.S. workers -- about 1 in 10 -- can draw a line from their job back to an auto factory or office worker, according to CAR.

CNBC. Those working directly and indirectly for the companies (ie. parts, HR, labor, etc. etc. etc.) and also it's affiliates, manufacturers, etc. I thought it sounded high BUT if true that changes the dynamic of there (or another employer of the same size to stay solvent).

So that number is quite inflated. If Ford and GM shut down today, I wouldn't stop buying gas or washing my existing car. And if I needed to buy a car, I'd have to buy a foreign one, driving up demand for them and most likely increasing the number of jobs necessary to support foreign plants in the US.

I'm not saying its a pretty picture if Ford or GM go down, but it isn't like 1 out of 10 people is unemployed within a month either.

No. TARP was never implemented. They only implemented the first step in the plan which was to buy all of the preferred bank stock.

And yet the program continues to be called TARP, which is weird. Unless the "troubled assets" being bought refer to bank stock.