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:

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 »

  • 21 Sep 2012 at 1:29 PM

The CDX And The Whale

The OCC report on bank derivative activities is rarely what you would call a laugh riot but I enjoyed that the 2Q2012 one released today gives the London Whale a belated sad trombone:

Commercial banks and savings associations reported trading revenue of $2.0 billion in the second quarter of 2012, 69 percent lower than the first quarter of 2012, and 73 percent lower than in the second quarter of 2011, the Office of the Comptroller of the Currency reported today in the OCC’s Quarterly Report on Bank Trading and Derivatives Activities.

“Trading revenues were weak in the second quarter,” said Martin Pfinsgraff, Deputy Comptroller for Credit and Market Risk. “While both normal seasonal weakness and reduced client demand played a role, it was clearly the highly-publicized losses at JPMorgan Chase that caused the sharp drop in trading revenues.” Mr. Pfinsgraff noted that JPMorgan Chase reported a $3.7 billion loss from credit trading activities, causing the bank to report an aggregate $420 million trading loss for the quarter.

How big a deal Whaledemort is depends on your denominator: compared to JPMorgan’s assets, or even its revenues, he’s a drop in the ocean, but his misadventures in credit derivatives did wipe out two-thirds of all derivative trading revenues among all US banks. And he’s a good enough excuse to talk about a random assortment of other credit-derivative-trading things from the last few days. First is a neat Bloomberg article (appears to be terminal-only now) about CDX NA HY 19: Read more »

  • 11 Jun 2012 at 12:03 PM

And Now, Spanish CDS

Did you think you could avoid it?

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 »

  • 01 Jun 2012 at 4:03 PM

The CDS Market For Lemons

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.

That sucks for the CDS writer, doesn’t it? Read more »

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

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 »