Credit Default Swaps

[HenryTo]

"Real Money" investors, such as pension funds and insurance companies, are now selling into the CDS market, given the immensely attractive spreads relative to current default rates:

http://www.ft.com/cms/s/0/6b6ae95e-f52c-11dc-a21b-000077b07658.html

[rffrydr]

Going PUBLIC a.k.a. regulated:

http://www.cnbc.com/id/27044623
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Today is the Tomorrow you worried about Yesterday!

[texfly101]

[nodoodahs]

You've answered your own question. Fear of an unknown risk creates a feedback loop that is self-defeating. Why now? Because earlier they were focused on greed. They're human, just like the poor retail schlub that sells out of his 401k into money markets at the bottom and then waits three years to get into China funds with it ...

Those rates have, at any one point in time, exactly as much to do with the underlying true cost of doing business as do stock market prices have a perfect relationship to the economic value of the underlying company. LOL

Markets are irrational because humans are ... and we make up the market ... understanding that and having just a bit of a rational edge are all you need to make money over the long term, although there's no guarantee you'll make money over any short term ...
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[texfly101]

In my layman's lack of financial knowledge, am I right in thinking that these rates are not the result of any particular specific algorithmic technical indicator that is based on past actuals for example, but rather are the result of discretionary bidding, personally assigned spreads by analysts etc, and are the measure of entities trying to cover the future unknown risk of failure rather than an analysis of potential to profit?
Is this in actuality the organizations saying that they don't want to do business and are trying to put such a high cost on it that the deal won't be made? I would think that this would be self defeating in that a good business model would not accept such punishing rates and the ones that would accept it are the ones you would have good reason to fear as they are trying to do business at any cost just to get their share of the cost of doing business...not because there is any real potential of profit.
I have a hard time with this wild upward swing in these rates as they don't seem to be the result of an underlying true increase in the cost of doing business, rather they are the result of a perceived unknown risk that operates like a feedback loop of self reinforcing rate increases not based on true costs.
Again, just another one of my meandering questions but it does seem to come up in my mind a lot lately. I mean, why now? Why not earlier when it was well known that these practices were of a very risky nature and had the high potential for failure versus the true potential for profit. I have done lots of business plans for development projects and knew when what I was calculating was a potential for profit rather than just building to get the fee for design. I have seen lots of commercial development failures in my time in FL and it wasn't hard to separate the purely speculative ones that were doomed for failure from the ones which had a good chance for making the owner a substantial profit.
I don't know how the CDS industry works, but I do know that when the commercial loan rates back in the 80's were in the teens that there few shopping centers developed because grocery stores couldn't service debts based on those exorbitant rates back then...dj
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dj

[HenryTo]

Not only is there no liquidity in the CDS market, but the likes of AIG Financial Products and hedge funds who were selling CDS contracts because of the historic spreads have been and are still being blown out of the water. That 30 bps CDS cost for US Treasuries is no doubt being fueled by those who sold the contract at 15 bps during March, or even 5 bps last year. As mentioned in another thread, the GE Capital CDS contract is now trading at 626 bps - up from a range of 10 to 15 bps during 2006.

[rffrydr]

Which just shows you how much faith to put in the CDS "market" right now. There's not much trading in not much over there. Even the LIBOR is a fiction. What's a price with no trades?

ps did you see the Google close?

http://www.latimes.com/business/la-fi-techblog1-2008oct01,0,7757353.story

Overbearing govt. interference?
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Today is the Tomorrow you worried about Yesterday!

[diesel]

More fun and games....

The cost of Credit Default Swaps on USTreasury debt has risen above 30 basis points, and now stands at a higher level than McDonalds, the fast food corporate chain. The USTBond swap was 22 basis points just a couple weeks ago, and only 6 bpts in April.

[nodoodahs]

This summarizes a take I heard on it ...

New financial structures were being handled by risk management systems designed for the last catastrophe; the new risks weren't captured by the systems and the models of the risk just weren't accurate. Supersenior risk was seen as low-delta, basically riskless, so nobody delta-hedged it. Then they carved it up, sold some of it, kept some of it. What should have been questioned was the assumption of risklessness, or the attitude that a greater fool will come along, or the documentation of just how custom these devices were and how outside of the models they were. Institutionally, it's also a failure of structure, because if these companies were still private partnerships, much of this wouldn't have happened.

From my take, you always have things outside your model. Always. But the more complex the set of assumptions, the more likely you are to run into something that you don't know you don't know. I mean, if you know that you don't know something, you can take precautions, but if you don't know that you don't know it? An argument for simple models and simple systems.

Leverage kills. I'm always back to that old saw, if you have to apply a lot of leverage to make your trade work, you really don't have that good a trading system, do you? I can see an occasional 2-3x leverage on a situational basis, but walking around with a carry on 20-30x is just finsane.

Liquidity is a function of price. These things are probably very liquid, just not at a survivable price - given the amount of leverage used. I think you can swing a lot of leverage in very liquid assets, or you can play in illiquid trades unleveraged, but you're tempting fate trying to do both.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[rffrydr]

The size IS daunting. This is still the bugs bugaboo:

http://www.financialsense.com/Market/pretti/2008/0926.html

While this guy acknowledges the zero-sum nature of the market he frets about that distribution. There is no clearing house...other than Lehman and company. What he doesnt' acknowledge is just how many analysts have already marked this exposure--on both sides!

That it's JPMorgan is a comfort at this point IMHO.



These comments are being written prior to any type of final resolution on the bailout package. I have no idea what it will look like in final form. First, it will be important to gauge intermediate term financial market reaction once some type of bailout package is passed. But then the hard work begins. Let’s assume relatively illiquid bank assets are swapped for liquidity, the next question for the macro financial sector and the real economy then becomes, will we then have willing lenders and borrowers? Capital conservation and accumulation is the critical issue for the banks at the moment. Moreover, we now have a US consumer weathering higher energy and food costs, wage growth below the headline CPI growth rate, declining household asset values (residential real estate and equities), and now a growing personal tax obligation as per the bailout mechanism. Sounds like really fertile ground for acceleration in borrowing and lending activities, doesn’t it? As a final comment, keep your eye on the credit markets. Although it’s just my opinion, the financial markets, real economy and financial sector will not heal until the credit markets heal. After all, the global credit markets put a definable price on “confidence” each and every day.
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Today is the Tomorrow you worried about Yesterday!