Let’s check in on Argentina. It’s a lovable mess! You can read some background here or here or here. In brief:
Argentina had some Old Bonds, decided not to pay them (in 2005, more or less), got most of their holders to exchange into New Bonds at pennies on the dollar, started paying the New Bonds, stopped paying the Old Bonds, the usual.
Elliott Associates bought up lots of Old Bonds at pennies on the dollar, didn’t exchange, travelled the earth suing and capturing warships and stuff.
Elliott won a big lawsuit against Argentina, getting a US district court and the Second Circuit to declare that Argentina couldn’t make any interest payments on the New Bonds without ratably paying off the Old Bonds.
Argentina doesn’t want to pay off the Old Bonds.
But it does want to keep paying the New Bonds.
The district court now has to, among other things, clarify its injunction saying that Argentina can’t pay New Bonds without paying Old Bonds.
Specifically: how, if at all, will that injunction apply to various people in the “payment snake” – indenture trustee, securities depository, banks and brokers and whatnots – that snakes between Argentina, which has the money, and the New Bondholders, who want it?
Simplistically: Elliott thinks that anyone in the snake who takes money from Argentina and passes it on toward New Bondholders is “aiding and abetting” Argentina in violating the injunction. The snake members are more of the opinion that they’re just a snake and can’t be held responsible for what passes through them.
The head of the snake is Bank of New York Mellon, the indenture trustee on the New Bonds, who are in the unfortunate position of getting money from Argentina and dishing it out to New Bondholders. If the injunction applies to BoNY, then they will be in contempt of court if they do their job. They don’t like this, and filed a brief last Friday saying why.1 They are not alone in this; various other bits of the snake and their caretakers – the New York Fed, DTC, the Clearing House Association, etc. – have expressed similar emotions. Read more »
Europe is doing various terrible things about short selling today, and go talk about them in the comments, but this whole thing is really boring isn’t it? It’s like the “price gouging is grrreat” arguments that spring up like weeds after natural disasters;1 there’s the thing that politicians do to Convey Emotion and then we over here in the blogs are all “aha that thing is emotional but wrong!” and we all feel good and rational. So let’s, there’s nothing to stop us, we are in fact good and rational and the politicians are in fact emotional and wrong, as we and they always are, so there’s nothing wrong with patting ourselves on the back a bit when it’s demonstrated particularly clearly. I guess.
So, yes, Spain is continuing its ban on short sales of stock for another three months, to reduce volatility, though it seems to have increased volatility,2 because that is how you pantomime “deep concern” to … someone … and “blind panic” to the financial markets. And Europe more broadly has a ban on (1) naked shorting of stock and (2) naked CDS positions that goes into effect today; some things to think about that include:
The regulation is a mess and is causing freakouts among banks, hedge funds, lawyers, etc.,
it is hard to imagine it not being bad for the European government bond market, and
One slightly different read of the pan-EU rules is that they are less about their ostensible emotional purpose – “don’t anybody say anything mean about European governments or banks” – and more about market-structural stability. Read more »
Coincidentally while I was noodling about bond indexes on Friday so was Goldman credit strategy research. Here I will show you a chart they made:
So what this is is performance of ETF, index-y bonds versus performance of otherwise similar but non-ETF, non-indexy bonds. Goldman took the bonds that are in the iBoxx US liquid investment grade index (IBOXIG), which underlies the $21 billion LQD ETF, and compared them to other bonds that are – take their word for it – similar, but not in the liquid index (but in the broader ICPRDOV index), and saw that the ETF-y ones outperformed the non-ETF-y ones – by about ~4% of price / 60bps of spread over the last three years. Here are some more words on the word you have to take for it: Read more »
Reuters had a neat article today about how JPMorgan’s CIO embarrassment increased credit spreads for a bunch of investment grade companies. The 121 companies included in the CDX.IG.NA.9 index, in which JPMorgan apparently had a $100bn long position, saw their CDS spreads spike in the days after JPMorgan revealed its losses – and its intent to unwind that position – last month. As Reuters puts it, those companies’ CDS spreads
became more like the pawns in a battle between JPMorgan and hedge funds on the other side of its bet. This struggle so dominated a corner of the market that it sent false negative signals about the credit quality of some major companies whose underlying finances were largely unchanged, market experts said.
JPMorgan, sort of strangely, disagrees:
A JPMorgan spokeswoman said there was no causal link between the credit derivatives prices and the trading tied to the bank’s losses. The theory, she said in an emailed statement, “is wrong and ridiculous.”
But the Reuters analysis showed the 121 companies underlying the index of credit derivatives at the heart of the trading battle had a sharper increase in default insurance costs than 41 companies in a separate index that was not believed to be part of the big bets.
That statistical analysis – CDS on companies in the index went up by more than CDS on some other companies – is more suggestive than compelling, but also more suggestive than “wrong and ridiculous.” I like suggestive when I can pair it with a story. What is the story – the actual trade that would do this? Read more »
So the deal is this. Spain has some banks, and those banks have some loans, and those loans have some problems. And so Spain wants to bail out its banks via a thing called the Frob, which is perhaps more confidence-inspiring in Spanish than it is in English? The Frob has the small problem of not having money, and this weekend the problem was solved by Europe – I like saying “Europe” because the actual institutions in these things always seem pretty ad hoc but in this case it means mostly the European Stability Mechanism but also the European Financial Stability Facility – promising it up to €100bn.
Now one thing about Europe is that it wants its money back, so the ESM loans will likely be senior to existing Spanish government debt. In some ways this is weird – Spain is financing a subordinated investment in the financial sector of its economy with a senior lien on all of its economy, and subordinated bailouts could both create more flexibility and give Europe upside in any recovery – but in other ways, this is the way the world works. As Zero Hedge put it, “the FROB loan is effectively a priming DIP”: when you really need the money, and you can’t afford to pay for it in rate, you pay for it in seniority.
This leads, theoretically, to sadness if you are a Spanish government creditor, because now you are subordinated. On the other hand, it leads, theoretically, to happiness because Spain is now funded through means other than a bond market that may shut at any moment, so it should be able to keep afloat and service its debt, including your debt, which is what you really want. Your expected recovery on default has gone down, but so has your probability of default, so there are offsetting effects. Which effect is bigger? That does not seem susceptible to an a priori answer but as of late this morning lower recovery seems to be winning: Read more »
A stylized picture of a credit default swap is that it’s a way for a bank to offload to the market the credit risk of loans that it makes, while still funding those loans and making a profit on them. If you start from that stylized picture, you must at some point get comfortable with the stylized fact that this market is probably rife with insider trading. Turns out it is! Part of the reason for that is that it’s maybe legal,* part of it is just the general run of market-participant scumminess,** but there’s also the fact that the basic model sort of requires it. Here is the basic model:
private side bank employees evaluate a company for a loan, using lender materials that contain nonpublic information and banker relationships that are all about nonpublic information,***
private side bank employees negotiate and fund that loan with a company,
[magic happens], and
public side bank employees buy CDS on some but not all of the companies that the bank lends to in sizes that vary among companies.
So, I mean, I generally trust that most banks are over-compliant on this point and the magic happens behind a Chinese wall and so forth, but still, that sequence of events should make you a tiny bit suspicious if you’re anti insider trading in CDS.
Anyway, if you continue on with that stylized picture you’ll notice that, while the existence of traded CDS allows for a two-sided market of public-market speculators who buy CDS to bet against companies that they don’t lend to (or that they lend to only in public bond form), the origin of and net demand for single-name corporate credit protection comes largely from banks who do private-side lending and are probably hedging that lending. This is basically true.
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.