cds

  • 09 May 2012 at 7:15 PM

Greek CDS Will Be Fixed Soon, In Case You Were Waiting On That

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As Greece prepares to default on its new bonds, now seems as good a time as ever to fix the problems that occurred when it defaulted on its old bonds. Remember that? Basically there was this thing where if you had a Greek bond with a face amount of €100 and CDS on that Greek bond, and that Greek bond got poofed into a new Greek bond with a face value of €20 that traded at par, then your CDS would pay out not the expected €80 that you lost on your first bond but rather €0 because the second bond was deliverable into CDS and it traded at par. Which makes no sense if you view CDS as hedging your losses on the first bond, which to a reasonable approximation you do.

Fortunately, though, in the particular case of Greece, the new bonds were split into lots of little tranches and one of them basically looked like the old bonds, value-wise (though not otherwise), and so everything worked out and actually made CDS buyers a little bit of extra money. So that was nice for them, but otherwise it was all just terrible.

So this gets a yay: Read more »

  • 09 Apr 2012 at 4:58 PM

You Say “Voldemort” Like That’s A Bad Thing

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Do you think that Bruno Iksil, when he woke up in Paris on Friday looking forward to trading from home in his black jeans, expected to become an international celebrity? The evidence suggests not. You may remember Iksil – possibly under other names like “Voldemort” or “the London Whale™” as the JPMorgan chief investment office trader who has sold protection on $100bn of notional of a CDX investment grade index to … hedge … JPMorgan’s massive short position in credit … or … something?* Anyway a lot of people are mad at him because that’s just too much protection to sell on that index and so they are complaining to Bloomberg and the Journal about how he is manipulating the market and also taking huge proprietary risks with JPMorgan capital that should obvs be regulated out of existence.

This is weird in a lot of ways but one of them is that you can distill a lot of the Volcker-Rule complaints into “my God, you’re telling me that JPMorgan is exposed to $100bn of credit risk on investment-grade debt issued by a diverse mix of 121 U.S. companies!?” No! JPMorgan is exposed to something like $750bn of credit risk on debt issued by a diverse mix of companies. Some of it’s non-US. Some of it’s not even investment grade. And that’s just in its loan book.** Is writing $100bn of protection on the CDX.IG.NA.9 a terrible risk to take with investor and depositor and government-backstop money? Well, define “terrible risk.” It’s certainly less risky than operating the rest of JPMorgan.*** Read more »

  • 19 Mar 2012 at 3:41 PM

Derivative Surprises Everyone By Accomplishing Purpose and Unwinding at Randomly Generated Market Value

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Yay, Greek CDS worked. But, as we talked about a bit, it almost didn’t:

By happenstance, some of the new bonds Greece has issued in its restructuring have a market price close to the total value of the package creditors received — about 22 cents on the euro. Those bonds will help set the CDS payout, and trouble will be averted: CDS holders will receive about 78 cents, roughly equivalent to the loss bondholders suffered. …

If the new Greek bonds had different terms — higher or lower interest payments for instance — their prices could be substantially different, changing the amount the default swaps would pay. Ben Heller, a portfolio manager at New York hedge fund Hutchin Hill Capital, which owns both Greek bonds and CDS, said that means the swaps aren’t doing their job. He said that until the problem is fixed, he “will not use CDS as a hedge against credit exposures anymore.”

In fact Heller told Felix Salmon:

When you think about it, it’s a product that, on certain poorly defined credit events, offers a random payout. So if I want to do that, then I could play roulette at a casino.

So, first of all: yes! I think worry about the definition of credit events is a bit overblown, but the randomness of the payout is a real thing and bizarre and terrifying. It bears re-emphasizing that the method of calculating the Greek CDS payout bears no relation whatsoever to the default risk that it was supposedly hedging.

But, also: no! Read more »

  • 02 Mar 2012 at 5:57 PM

This Is The Last Greek CDS Post Ever*

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There’s that famous scene in Liar’s Poker – are there non-famous scenes in Liar’s Poker? – where the much maligned equity department sends a program trader to impress Michael Lewis’s jackass fellow Salomon trainees with his brilliance. It does not work:

He lectured on his specialty. Then he opened the floor to questions. An M.B.A. from Chicago named Franky Simon moved in for the kill.

“When you trade equity options,” asked my friend Franky, “do you hedge your gamma and theta or just your delta? And if you don’t hedge your gamma and theta, why not?”

The equity options specialist nodded for about ten seconds. I’m not sure he even understood the words. … The options trader lamely tried to laugh himself out of his hole. “You know,” he said, “I don’t know the answer. That’s probably why I don’t have trouble trading. I’ll find out and come back tomorrow. I’m not really up on options theory.”

“That,” said Franky, “is why you are in equities.”

This is totes unfair to the actual equity vol traders I know, but I kind of felt like that guy after talking to a CDS lawyer yesterday about this craziness in Greece. It went something like this:

Me: As an equity derivatives guy, I expect derivatives to transform into derivatives on whatever their underlying transforms into. And I’m troubled by them not doing that.
Lawyer: You should not be troubled by the concept of cheapest to deliver.

Yeah fair! That’s the thing about CDS. Dopes like me think of it as just a rough proxy for default risk but when things get real like with Greece it turns into a cheapest to deliver convexity play and then I slink away in embarrassment. But yeah, as a matter of rough justice, if you can go be opportunistic about finding the cheapest to deliver bond, Greece can go be crappy about leaving you with only expensive to deliver bonds. I guess. Read more »

  • 01 Mar 2012 at 2:05 PM

So Maybe Greek CDS Won’t Be Fine, Who Knows, I Give Up

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ISDA decided today that there has been no credit event for purposes of Greek CDS. Obvs! And by “obvs!” I mean what I said the other day, which is that with 100% certainty there’s been no credit event yet, but with 100% certainty there will be, so everyone should just chill out.

Except that it seems like that last part may be wrong. So go ahead and panic.

I used to make convertible bonds and some of my time was spent answering questions about what happened to things upon Events. The most popular was: what happens after a merger? If you have a convertible that converts into 10 shares of XYZ stock, but now XYZ is being acquired and each share of XYZ is being acquired for $30 in cash and 4.5 shares of PQR stock and a pony – what happens to the convertible? And the answer I would give usually started with “don’t trouble your pretty little head about it.” Like, it’s fine: you have a convertible that converts into 10 Things, and before the merger each Thing was an XYZ share, and after each Thing is exactly what an XYZ share transformed into, so you convert into $300 and 45 PQR shares and 10 ponies. It just works because it has to work. Economic interests follow without interruption from changes in form; derivative securities poof into derivatives of things that the underlying poofs into. There is no arbitrage!

That assumption is central to doing any sort of derivative work, and it spoiled me a bit. Sometimes people would come up with more complicated scenarios involving dividends, multiple-step transactions, weird splits and spinoffs and sales, etc. etc. And I would generally start from the bias “it has to work, so I am sure the document written in the way that works.” Where “works” means “the economics and intent of the trade are preserved after the change in form.” But of course the document was written by humans, often specifically me, and those humans, often including me, are fallible. So there may well be documents from my former line of work that don’t “work” in the sense that an issuer could do some structural tricks that would screw holders out of their economics – where the derivative doesn’t follow the underlying everywhere it might go. These tricks are unlikely enough that I don’t lose sleep over them. You can’t predict everything.

I sort of assumed that Greek CDS also had to just work but here is Felix Salmon at Reuters saying no. Lisa Pollack at FT Alphaville said something similar a week ago but I could not fathom that she meant it so I read it to mean something else. But she means it, and Felix does too. Go read it but the basic gist of this theory is: Read more »

  • 28 Feb 2012 at 7:08 PM

Greek CDS Would Be Fine If People Would Just Leave It Alone For A While

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Somebody once said that “The Greek CDS situation is sort of puzzling, but it’s possible, and popular, to overstate its puzzlingness.” People just cannot resist doing that can they?

CDS is sort of simple. Here is the lifespan of CDS:

(1) You buy a CDS contract on undefaulted bonds in sunny times.
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(n) Those bonds default and you get a payoff. (Or they don’t and you don’t.)

In the middle things happen. Those things live in your heart and mind and the trading price of the CDS and you have mark-to-market collateral (you do, right?) so they have a real presence in your life. But those things don’t live in the CDS. The CDS contract is just a thing that does nothing until there’s a default, and then it does something. Read more »

  • 22 Feb 2012 at 6:29 PM

One Last Greek CDS Post Before It All Goes Poof

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One of the side benefits of Greece taking whatever somewhat irreversible steps it is now taking is that something will happen to CDS written on existing Greek debt and that will mean that we can stop talking about what will happen to CDS written on existing Greek debt and start talking about more interesting things like quasi-CDS written by the EFSF on shaky Eurozone government debt.

For now, though, we’ve got at least a few more weeks of surprisingly and unsurprisingly ill-informed fretting that triggering the $4bn of Greek CDS will Bring Down The Entire Global Financial System. That seems sort of silly because notionals aren’t that big, mark-to-market collateral is mostly being posted, and at this point the marks are pretty close to what you’ll get from Greece so it doesn’t look like there’s tons of unknown unrecognized losses lurking out there.

On the other hand, we’re mostly through with the speculation that not triggering Greek CDS will Prove That CDS Is Worthless and thereby Bring Down The Entire Global Financial System, so that’s nice. The reason that’s mostly over is that it sure looks like Greek CDS will in fact trigger, as Athens has moved to adopt a collective action clause that will flip the Greek restructuring from “voluntary, heh heh heh” to “involuntary” and thus trigger the ISDA restructuring event definition. You can argue that the mechanics of the cash settlement auction will mildly screw CDS holders but I’m not so sure, and in any case this is pretty solidly in the category of derivatives nerdery rather than Bring Down The etc. Read more »

  • 10 Jan 2012 at 7:16 PM

Jerks To Get Paid More Than Nice People

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No, not your comp, though probably that too. The Times and the Journal check in today on the state of play in Greece and it’s kind of how you might expect. From the Times:

For months now, Greece has desperately been trying to persuade its private-sector creditors that it is in their interest to exchange their existing Greek bonds for longer-term securities and accept about a 50 percent loss as part of the bargain. The negotiations are known as the private sector involvement, or P.S.I.

A few months ago the deal looked doable, as the large European banks that held must of this debt, estimated to be around €200 billion, recognized that it was probably a better alternative than default, which could cost them everything. Moreover, the banks were sensitive to political pressure from their home countries, where they have a big stake in remaining on good terms with the government and key officials.

But as the talks have dragged on, many of these banks, especially big holders in France and Germany, have sold their holdings. Among the buyers have been hedge funds and other independent investors who are now questioning why they should accept a loss, known as a haircut, if, as it turns out, the deal remains voluntary in nature and Greece keeps paying interest on its debt.

And as the number of such hedge funds holding Greek debt has grown, so has their ability to forestall a restructuring agreement, thus bringing them closer to being able cash in on their high-stakes gambit.

From the Journal:

There are many potential pitfalls, each, in a way, leading to another pitfall-strewn path.

Ha! Also ha! on the Times’s sort of strange description of what the hedge funds are up to, though what they’re up to doesn’t itself sound strange. If I were a hedge fund here is what I would do:

1. Not buy bonds and then later “question why I should accept a loss”;
2. rather, buy bonds because I plan to get a gain;
3. specifically because I’m planning to be all “oh, man, I must have lost that consent solicitation in the mail, could you send it again” and otherwise generally stall on this voluntary offer until my bonds come due and are paid off with bailout money (maybe?);
4. or, alternatively, because I’ve got CDS against those bonds and have no intention whatsoever of voluntarily exchanging them and voiding my protection.

That or “stay the hell away from this situation.” But, like, the above is at least a strategy. Now, if I were a French or German bank here is what I would do: Read more »

  • 10 Jan 2012 at 1:18 PM

The SEC Wants Banks To Tell You Where They’re Hiding Their Terrible European Exposure

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You can’t argue too much with the SEC’s gentle suggestion that maybe banks should tell people, in a consistent format, what’s up with their European debt exposure. It seems to be a thing that is on investors’ minds, so why not have the SEC try to put their minds at ease:

“Our staff has been working with banks to improve their disclosure about sovereign-debt exposure for several months,” SEC Chairman Mary Schapiro said in a written statement released Monday. “Even so, I understand this is an area of focus and uncertainty that could really benefit from further transparency and consistency, particularly as we head into annual reporting season. I think the staff’s guidance should help achieve that goal.”

Yep. The release is here and contains a good list of things you might want to know, including things like “The effects of credit default protection purchased separately by counterparty and country,” “The fair value and notional value of the purchased credit protection,” and “The types of counterparties that the credit protection was purchased from and an indication of the counterparty’s credit quality.” It’s not exactly a standardized form for disclosure that will allow everyone to do detailed comparison among the banks and/or sleep well at night, but it should at least shame people into giving reasonably detailed substantive information so that when your bank blows up you at least won’t be surprised at which European country did it. That seems good. It even seems like what the SEC is supposed to do.

The Journal, ever fair, finds a token objector, sort of: Read more »

  • 16 Dec 2011 at 1:23 PM

It’s Not So Easy To Get Away From This Voluntary Greek Bond Swap

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Bloomberg reported today that, back in July, David Einhorn and some other people decided that (1) betting against European sovereign debt was, and would remain, a good idea, but (2) doing it in CDS form was kind of dumb, so (3) they’d switch to doing it in physical form, by borrowing and shorting the debt. Here’s what Einhorn had to say in his July investor letter:

The letter touched on two risks tied to credit swaps on European sovereign debt, including regulators’ attempts to fashion a Greek bailout in a way that prevented the contracts from paying out. The second risk was the possibility that banks that wrote billions of dollars in credit swaps on sovereign debt might not be able to make good on their obligations should a country such as Greece actually default.

Let’s talk about that first reason for a minute because I think it’s sort of illuminating. The problem is that Europe was in July, and is now, and wow that’s depressing, trying to cobble together a “voluntary” debt exchange where holders of Greek debt happily hand it in to Greece and get back a thing with a 50% face value haircut that is also a piece of crap. If you’re a European bank who owns Greek bonds and CDS to hedge them, and you feel pressured to accept that deal, then you feel like the “insurance” you bought on your bonds should “pay out,” I suppose, though that’s all fairly hypothetical. If on the other hand you’re David Einhorn and you bought CDS and then Greece haircuts its debt, you feel like your bet against Greek debt has been vindicated so it should pay out. But it doesn’t, says ISDA, because the exchange was voluntary and there was no “credit event” under the rules governing your CDS. Read more »

  • 12 Dec 2011 at 3:12 PM

New Report Features CDS And Shadow Banking, Is Not In The Sunday Times

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Here is a wonderful sentence:

A key insight from the enhanced BIS credit derivatives data is that non-rated multi-name credit risk sourced from multiple sectors has been transferred from derivatives dealers to IFGCs, SPVs and OFCs.

Yeah! Wh … what?

It’s from the quarterly review of the Bank for International Settlements, which is a delightful hodgepodge of hard-to-read charts, hard-to-read sentences, and general oblique glances at the guts of the global financial system. It is both glancing and gutsy. There are reams of tables. Give it a read.

The quote above is about this:

Everything clear now?

I love charts and all but I mostly think in stories, and I’m trying to parse together the story for these facts because they seem somehow important. It seems to go like this. Read more »