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 »

  • 08 Mar 2012 at 4:54 PM

So Maybe Greek CDS Will Be More Than Fine?

Gaaaaaaaaaaaaaaaah Greece.

Okay so all systems appear to be go on the Greek debt exchange, which means its time to decide What This Means, and, I just. Really. Greece. Come on. All I want is to talk about 13D reporting requirements, and now I have to pay attention to Portugal? No. Just no.*

Still here is arguably a fun factoid:

On Wednesday, Swiss bank UBS AG started quoting a “gray market” in new Greek sovereign bonds … using as a guide details of the debt swap Greece has put on the table for private investors to accept until Thursday evening. The “bid” price for a batch of future Greek bonds due in 2042, or the highest price the dealer was willing to pay, was around 15 cents on the dollar; the “offer” price, or the most the dealer was willing to sell at, was 17 cents on the dollar, the first person said. … The prices quoted by UBS imply that losses private creditors to Greece will take are more like 79% of face value, not the original haircut of 70-75% many had expected.

Yeah but. If you believe this horrible CDS mechanics stuff that various people including me have been yammering about for weeks – here is the best explanation – that means that if for some reason you had the foresight to be long Greek bonds and hold CDS against them you’d end up with a package worth (1) 21 on the bonds and (2) 83 on the CDS (assuming that the 17 offer for the 2042 bonds represents a real price for the cheapest-to-deliver new bond in the Greek auction) for (3) 104 total which is (4) more than par, so you win this particular game, yay. Which you were at risk of losing – a week ago one of our fearless commenters spotted the longest new bonds at 25ish vs. 24ish for the old-bond-y package, for a total of 99 for the hedged holder – losing 1 point versus par.** Read more »

  • 02 Mar 2012 at 5:57 PM

This Is The Last Greek CDS Post Ever*

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 »

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.
(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

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

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 »

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 »