Global Debt Time Bomb explodes soon

[phil_in_cs]

I'm no expert, but:
1. All private borrowers are now offically in line behind the national banks and bigger/privileged private banks. Those got 100% - everyone else took a hit.
2. CDS are worthless if the parties can finagle a way around getting a CDS event declared when they want to.

I don't know how that will effect the market in the long run. I don't expect the ECB and others do either.

[raptor]

I'm no expert, but:
1. All private borrowers are now offically in line behind the national banks and bigger/privileged private banks. Those got 100% - everyone else took a hit.
2. CDS are worthless if the parties can finagle a way around getting a CDS event declared when they want to.

I don't know how that will effect the market in the long run. I don't expect the ECB and others do either.

Sovereign credit default swaps have always struck me as an exercise in absurdity.

[Kommander]

I'm no expert, but:
1. All private borrowers are now offically in line behind the national banks and bigger/privileged private banks. Those got 100% - everyone else took a hit.
2. CDS are worthless if the parties can finagle a way around getting a CDS event declared when they want to.

I don't know how that will effect the market in the long run. I don't expect the ECB and others do either.

Sovereign credit default swaps have always struck me as an exercise in absurdity.

Can you expand upon this for those who don't know the industry like you do?

[raptor]

I'm no expert, but:
1. All private borrowers are now offically in line behind the national banks and bigger/privileged private banks. Those got 100% - everyone else took a hit.
2. CDS are worthless if the parties can finagle a way around getting a CDS event declared when they want to.

I don't know how that will effect the market in the long run. I don't expect the ECB and others do either.

Sovereign credit default swaps have always struck me as an exercise in absurdity.

Can you expand upon this for those who don't know the industry like you do?

I am no expert in CDS. Mainly because I never buy debt that I do not consider credit worthy unless I am playing in the junk bond/troubled bond arena and am buying at a very steep discount.

However my opinion is thus:

CDS contracts are written around defaults. Thus if you wanted to buy a bond from a major worldwide company, say AIG, GE, BAC, etc. You could buy a CDS to "insure" your position against default. This CDS would in theory repay you in the event that there was a default as defined by the terms of the CDS.

The market place where you are likely to buy this CDS is quite likely to include the very large company you are trying to insure. For instance AIG was the party insuring a lot of CDS paper in 2008. Thus if there is major economic shit storm like the fall of 2008 your CDS may be backed by the very entity you are worried about. So while you have "insurance" it may or may not be worth the paper it is written upon since the guarantee is only as good as the guarantors's financial position. That said there can be a case for CDS on private debt and with the above in mind; it still can make sense.

The problem I have with sovereign CDS is quite different and can be seen in the Greek "default/restructure". This particular Greek plan is technically not a default. Thus it is unlikely that the CDS you bought to protect the value of your Greek bond will be required to payoff. Let me repeat that the 53.5% loss you took is not a default under which a CDS is required to pay off. They set up the restructuring purposely to avoid this possibility and said so publicly. Many of the "Private Investors" are funds controlled by the very entities that are parties to the CDS on Greek debt. They thus take a loss on the debt side but they avoid a bigger loss on the CDS side. The investors who are objecting and holding out are most likely the ones who are taking a real haircut.

Where sovereign entities are concerned, all bets are off. They make their own rules. A CDS for sovereign debt is not likely to be useful to an investor in sovereign debt. This is because the CDS issuer is likely at the negotiating table making sure his interests are served. Your interest most likely not be aligned with the key creditors.

BTW the above is my opinion. I am not stating it is an absolute fact.

I would be interested in the opinion of others who do deal in CDS and sovereign debt or anyone with a different view point on the matter (so long as it is an informed viewpoint please).


Edited to add:
A really good site to keep up with CDS pricing.
http://workforall.net/CDS-Credit-default-Swaps.html

[Kommander]

So why even bother if these guys are just going to change the rules on you?

[phil_in_cs]

So why even bother if these guys are just going to change the rules on you?

That's the point I took, and why I am not sure if anyone knows what the fallout of all this will be. People bought the insurance or they wouldn't have taken the risk - if the insurance is worthless, they won't buy the lower rated bonds except for 20 cents on the dollar or something. That would make it very difficult for lower rated nations to sell debt.

[raptor]

So why even bother if these guys are just going to change the rules on you?

That's the point I took, and why I am not sure if anyone knows what the fallout of all this will be. People bought the insurance or they wouldn't have taken the risk - if the insurance is worthless, they won't buy the lower rated bonds except for 20 cents on the dollar or something. That would make it very difficult for lower rated nations to sell debt.

The key take away IMO is nothing is guaranteed except the existence of risk. Invest accordingly and never rely on the assurances of the debt instrument issuer.

Let me give you a simple analogy.

In the case of sovereign debt you are lending money to politicians. You are counting upon them to repay you as they promised. Now you do not have to worry about getting repaid or politicians lying about this matter (not that politicians ever lie)... your banker said the risk was covered...by your CDS or insurance.

[phil_in_cs]

The CDS may still have to pay out.
http://www.forbes.com/sites/afontevecch ... rivatives/

UPDATE 2 (2:48 p.m.): ISDA has now declared that Greece’s restructuring does represent a default, meaning credit default swaps will trigger.

[raptor]

The CDS may still have to pay out.
http://www.forbes.com/sites/afontevecch ... rivatives/

UPDATE 2 (2:48 p.m.): ISDA has now declared that Greece’s restructuring does represent a default, meaning credit default swaps will trigger.

You are right.

Both Nomura and Barclays have come out expecting the ISDA to rule in favor of a credit event, thus triggering CDS protection.

Any bets about whether these two banks are long on Greek debt and not long on the Greek CDS exposure?

Edited to add:
That is good article on CDS and their future. A great find Phil! Thanks.


Here is another link about this subject:
http://www.bloomberg.com/news/2012-03-0 ... rules.html

The viability of credit swaps as a hedge for about $257 billion of government debt was questioned after ISDA rejected a request on March 1 to declare whether the swaps were triggered because the restructuring effectively subordinated private investors to the European Central Bank. Banks, hedge funds and institutional investors use swaps to protect against losses or to speculate on creditworthiness.

[drunkensurvivor]

Portugal Yield at 13%
http://www.bloomberg.com/news/2012-03-1 ... redit.html

The good news is Greece won’t default on March 20, and 10-year borrowing costs for Spain and Italy have dropped below 5 percent. The bad news is similar- maturity Portuguese bonds still yield more than 13 percent.

Spanish and Italian yields are getting back to sustainable levels, but even with the ECB liquidity Portugal's yields are still at incredibly unsustainable levels. Somethings still got to give here. I think if they deal with Portugal they can kick the can pretty far down the road. The situation might be fixable with simple moderate inflation and budget discipline after that.

[raptor]

Some interesting news. The Fed released the results its stress tests early and unexpectedly.

It seems that JP Morgan released their scores early.I wonder what the Fed will do about that.

The interesting news is that 4 banks failed the stress test and thus cannot increase dividends or buy back shares to get their share price up.

The list includes B of A (no surprise), Citigroup, Ally Financial Inc. (a.k.a GMAC bank) , MetLife Inc. and SunTrust Banks. Citigroup is a real surprise and it will be interesting to see what happens to these entities.

Based upon these published results the 3 safest US banks are State Street, Bank of NY Mellon and American Express.

Watch the good banks shares prices jump tomorrow and the bottom tier share prices get hammered.

http://online.wsj.com/article/SB1000142 ... %3Darticle


For what this is worth I consider this good news. The banking system still has stress and issues. The fact that 4 banks failed AND the Fed released this fact is IMO very telling.

[Blast]

The fact that 4 banks failed AND the Fed released this fact is IMO very telling.

Being clueless in the ways of high finance, I have to ask what does this imply?
-Blast

[raptor]

The fact that 4 banks failed AND the Fed released this fact is IMO very telling.

Being clueless in the ways of high finance, I have to ask what does this imply?
-Blast

This is strictly opinion on my part based upon logic but nothing else. So take it for what it is worth...an internet opinion.

The first stress tests were not made public. This to me implied that things were much worse than the Fed chose to tell the world. The fact that they made these results public is IMO equally telling that things have improved within the banking system after 3 years. The fact that 4 banks failed IMO indicates that the test were at least difficult. B of A has been a troubled bank for quite some time. It is common knowledge. The same for Sun Trust and Ally. However Citi was assumed to be relatively healthy. Thus it was surprise when they failed. This also IMO indicates that the tests were fair.

Now the politics of this data (with an election around the corner) IMO also affected the decision to release this data. However, that is the subject for discussion on another forum.

As an aside I think it is amazing that JP Morgan scooped the Fed and I suspect someone is in real trouble over this matter. Someone will pay for that disclosure with some body part, organ or genitalia.



Edited to add: Well half of what I sad happened. B of A 's share price rose over 3% today since teh bad news was a) expected and b) not as bad as everyone thought. Citigroup on the other hand is down over 3% because the market does not like surprises.

[drunkensurvivor]

Just to clarify, Bank of America(BAC) did pass the test... thankfully, since I'm holding BAC leap calls and the stock has been responding accordingly .

Bank of America Corp., which passed this year's test but didn't ask for any buyback or dividend increase, last year had a request for a dividend increase rejected by the Federal Reserve, a major embarrassment for the bank

I was going to post about this in the "bank failures" thread, but it ended up here first. I didn't read actual results of the test, but I've read some second-hand snippets. Citigroup had pretty ridiculous loan loss rates reported in this test... also, the hypothetical scenario that they were testing is dang near a doomsday scenario. Not out of the question, but tough to see happening anytime soon when we are in what looks to be the beginning stages of a healthy, sustainable recovery. The majority passed this test, and the numbers shown in the failures were dramatic enough to show this was actually an honest to god stress test, and not just political theater... to me that shows that the test was basically the final chapter of the banking crisis, and its essentially over. Banks have rebuilt their balance sheets and beefed up their capital ratios and what not. We're not gonna end up with the Japanese zombie banks that everyone was scared of. The banking industry will recover quite well if we get a housing recovery relatively soon, and will survive just fine even if we don't.

Link to Bloomberg article(my preferred financial news source):
http://www.bloomberg.com/news/2012-03-1 ... nario.html

A couple quotes that sum things up pretty well:

The resilience of the largest U.S. financial firms when tested against a recession more severe than the last one shows regulators have succeeded in pushing banks to build fortress-like balance sheets.

“Any bank that remains adequately capitalized under these acute stress scenarios is not just strong but also darn-near impregnable,”

[raptor]

You are right B of a did pass. The early article did not say it did I was reviewing the graphic and made that assumption.

I agree with your comments about the robustness of the testing.

[DialM]

I would be willing to wager that the stress of four major banks failing was not included in the stress test.

[raptor]

I would be willing to wager that the stress of four major banks failing was not included in the stress test.

Actually if you look at the tests they did not do that but the worst case conditions were similar to the conditions that existed when Lehman Bros failed. But you are right the one thing they cannot replicate, the wild cards risks of fear and uncertainty that existed then.
Certainly the failure of 4 banks within a month would shake the core banking foundations.

All that aside IMO the banking system while not recovered is far more robust than in 2007 much less 2008. I think that is the key take away form this testing.

The recovery IMO should not be surprise. Look at the huge number of banks closed in the last 3 years and the huge losses that we the consumers will be paying for (in increased bank fees/costs etc.) some time to come. The FDIC has depleted its reserves and required advanced fee payments twice IIRC.

So yes the banks damn well better be in better health. Now to eliminate the too big to fail aspect.

[Valarius]

So yes the banks damn well better be in better health. Now to eliminate the too big to fail aspect.

With all due respect, I believe most of the banks passed their stress tests because they're all currently sitting on large amounts of cash and refusing to loan it out. It's easy to theorize you can survive any financial disaster when you can point to your vault and say "we've got you covered, no worries." Of course, anything that also requires the banking sector as a prerequisite of functioning--such as anything/one/whom that uses cash, check or credit cards--will wither and die in a fire. But banking will survive. I'm not bitter.

[raptor]

So yes the banks damn well better be in better health. Now to eliminate the too big to fail aspect.

With all due respect, I believe most of the banks passed their stress tests because they're all currently sitting on large amounts of cash and refusing to loan it out.

The alternative is much worse for everyone.

[phil_in_cs]

re: Inflation. While the stated levels by government is low, we all know that's fudged lower to some extent. In General Mills latest earning reports, where they face civil and criminal penalties for reporting errors, they state they see 10-11% year on year inflation

http://phx.corporate-ir.net/phoenix.zht ... highlight=

Chairman and Chief Executive Officer Ken Powell said, “Our third-quarter results reflect strong worldwide sales growth for our business, but the 10-11 percent input cost inflation we’re experiencing this year pressured our margins. In the fourth quarter, we expect to generate continued good sales momentum and we anticipate that gross margin contraction will ease somewhat. This should result in renewed earnings growth as we wrap up 2012 and move into the new fiscal year.”

bold by me.

[NoAm]

Seeing the latest conversations on CD's, etc., makes me think of the bonds we used to purchase back in the 90's.
We would buy a bond with each of Mr. NoAm's paycheck (twice a month) $50 to be valued at $100 in x amount of years (7 or 10 years comes to mind right now).
Is this still even available? I know the bonds we hold still have value, but what are the options out there now for purchasinf bonds, etc.?
Just curious.

[phil_in_cs]

Seeing the latest conversations on CD's, etc., makes me think of the bonds we used to purchase back in the 90's.
We would buy a bond with each of Mr. NoAm's paycheck (twice a month) $50 to be valued at $100 in x amount of years (7 or 10 years comes to mind right now).
Is this still even available? I know the bonds we hold still have value, but what are the options out there now for purchasinf bonds, etc.?
Just curious.

Zero Coupons? Meaning, no actual paid interest, but you get the return when the bond matures? Yeah, those are still around. You are deferring the income to the future (since there's nothing realized until the maturity) which may or may not make sense based on tax rates. They used to be popular for people to buy for a child, to mature for college money (child is at a lower tax rate than parent) or to purchase to mature after retirement (when you are in a lower tax bracket)

[NoAm]

Thanks Phil! It's been SO long since we have tinkered with bonds. I was just curious. I think they were E's or EE's?
We cashed ours out a long time ago, but Lil NoAm has received a bunch over the years. I think they have all matured now.

[phil_in_cs]

Thanks Phil! It's been SO long since we have tinkered with bonds. I was just curious. I think they were E's or EE's?
We cashed ours out a long time ago, but Lil NoAm has received a bunch over the years. I think they have all matured now.

I never purchased any - mom and dad used these for my nephew's college money and for their own retirement. Since I have a 401(k) that's what I am using for mine.