Felix Salmon

Chart of the day: Greek bonds and CDS

Felix Salmon
Feb 25, 2010 22:07 UTC


Many thanks to the wonderful Stephen Culp for putting this pretty chart together for me. It shows pretty clearly, I think, that the narrative in today’s NYT piece — that CDS spreads gapped out, with a nasty effect on Greek bond spreads — isn’t really borne out by the facts. What this chart says to me is that both CDS and bond spreads increased pretty steadily over a period of two or three months, as perceptions of Greece’s creditworthiness deteriorated. And that Greek CDS spreads were pretty flat on either side of the introduction, in September 2009, of the iTraxx SovX Western Europe index.

More generally, this chart shows that the fixed-income markets are working in exactly the way that they’re meant to work, and that the CDS market is the Greece grease enabling them to do so. In an efficient bond market, the secondary-market yield on any given credit’s bonds is very close to the rate at which that credit can issue in the primary market. It can fluctuate up and down, but that changes the price of credit more than the availability of credit.

That’s exactly what we can see in this chart: Greece was able to issue the whole time, at steadily-higher spreads. And anybody who remembers the credit crunch of 2007-8 knows that that is just about the best possible outcome that can be expected, especially when you’re dealing with a borrower who (a) has €25 billion of financing needs in the next three months; and (b) has been so good at hiding its true debt and deficit figures in the past that they’ve lost the trust of the markets.

In markets which, as we’ve seen, are prone to panic, it’s pretty obvious what one might expect to happen in such a situation: investors would be likely to start selling their Greek bonds en masse, and there’s no way that Greece could borrow another penny on the open market.

In the event, neither of those two things happened — thanks largely to the CDS market. You don’t need to sell your Greek debt if you can hedge it in the CDS market instead, where there’s evidently a pretty deep group of investors willing to accept hefty insurance premiums over the next few years and bet that there won’t be an event of default. It’s a much easier way of making money than buying Greek bonds outright, which requires a lot more cash up front.

In turn, the ease of hedging marginal Greece exposure in the CDS market made helped to ease the fears of investors active in the primary market, and Greece has continued to be able to issue debt without interruption.

So rather than demonize the CDS market and blame it for Greece’s current woes, let’s place the blame firmly where it belongs — with Greece itself, and its profligate ways. And let’s thank the CDS market for adding enough liquidity to the bond market that Greece’s fiscal woes didn’t become a major liquidity crisis.


Agree with MG. I don’t see how these charts tell us anything about the effect of naked CDS positions on the cost of borrowing for Greece. The CDS and bond spreads are linked by an arbitrage-based parity relationship, they have to move in tandem just like spot and futures prices for an index or commodity. The chart tells us about changes in the cost of borrowing, nothing more.

Posted by rajivsethi | Report as abusive

CDS demonization watch, Greece edition

Felix Salmon
Feb 25, 2010 18:14 UTC

My CDS Demonization Watch has been on the back burner for a while: I thought that the caravan had moved on. But right now, the most-read story in the NYT business section, getting a lot of attention in the Twittersphere, is this one, headlined “Banks Bet Greece Defaults on Debt They Helped Hide”. It’s gaining a lot of traction: Ben Bernanke said today that he’s looking into the issue of whether the CDS market is enabling some kind of run on the Greek government. I sincerely hope he was just being polite to his Congressional overlords, rather than buying in to this theory.

It’s worth looking at the NYT story in some detail, to see just how little sense it makes.

Bets by some of the same banks that helped Greece shroud its mounting debts may actually now be pushing the nation closer to the brink of financial ruin.

Echoing the kind of trades that nearly toppled the American International Group, the increasingly popular insurance against the risk of a Greek default is making it harder for Athens to raise the money it needs to pay its bills, according to traders and money managers.

The first thing worth noting here is that Greece is not anywhere near the brink of financial ruin. The CDS market is actually very good at showing when a borrower is near financial ruin: when that happens, spreads gap out past 1,000bp to something closer to 2,000bp or even 3,000bp. Greece’s CDS spreads peaked at about 400bp, which is high for an EU country, but is nowhere near distressed levels. Yes, every time the CDS spread rises it gets closer to distress, but that’s just as true — and just as unhelpful — if it goes from 30bp to 40bp.

The second point to note about these opening two paragraphs is the curious presence of AIG. AIG went bust because it wrote insurance; the NYT story is here implying that there’s some relevance to what’s happening with Greece, a reference credit that people are writing insurance on. AIG had to pay out billions of dollars to make good on CDS contracts; Greece has neither bought nor sold any CDS contracts at all. No sooner are the parallels made than they break down.

That doesn’t stop the NYT, however, which then proceeds to wheel out the cliché about CDS being “like buying fire insurance on your neighbor’s house”. The problem is that the analogy just doesn’t work in this case. Much later on in the article, after most people have stopped reading it, we’re told the truth of the matter:

European banks including the Swiss giants Credit Suisse and UBS, France’s Société Générale and BNP Paribas and Deutsche Bank of Germany have been among the heaviest buyers of swaps insurance, according to traders and bankers who asked for anonymity because they were not authorized to comment publicly.

That is because those countries are the most exposed. French banks hold $75.4 billion worth of Greek debt, followed by Swiss institutions, at $64 billion, according to the Bank for International Settlements. German banks’ exposure stands at $43.2 billion.

These banks aren’t buying insurance on someone else’s house, they’re buying insurance on their own house. As the old saying goes, if you owe $75,000 to the bank, you’ve got a problem. If you owe $75 billion to the bank, the bank has a problem. And in this case, the banks are doing their best to deal with that problem and manage their risk proactively.

The question here is whether their ability to do so in the CDS market is exacerbating matters for Greece. The mechanism here is complex, if it exists at all:

As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that bearish signal, bond investors then shun Greek bonds, making it harder for the country to borrow. That, in turn, adds to the anxiety — and the whole thing starts over again.

At the very least, this does a large disservice to bond investors. They’re not sheep who are happy to lend to any country unless or until its CDS spreads widen — in fact, at the margin, they’re more likely to lend to a country if they know that they’ll always be able to hedge that position in a liquid CDS market. Now, it’s true that as worries over Greece’s creditworthiness get more intense, Greece’s cost of funds goes up. But there’s a strong case to be made that absent the CDS market, Greece simply couldn’t borrow at all: the existence of the CDS market has made it easier (if more expensive) for Greece to borrow money, not harder.

There is a connection between the CDS market and the cash bond market, thanks to the concept of delta hedging — people who sell credit protection on Greece will often end up selling Greek bonds at some point in order to manage their exposure. But that connection is much more tenuous than the alternative, which is that of banks looking to reduce their Greece exposure all dumping their Greek bonds onto the market at the same time. The result of that kind of operation would be spreads much wider than 400bp.

The weirdest bit of all in the NYT article is the way it places the blame not on people trading Greek CDS, but rather on people trading a more general sovereign CDS index:

Last September, the company, the Markit Group of London, introduced the iTraxx SovX Western Europe index, which is based on such swaps and let traders gamble on Greece shortly before the crisis. Such derivatives have assumed an outsize role in Europe’s debt crisis, as traders focus on their daily gyrations.

If you want to gamble on Greece, you can gamble on Greece: gambling on a broader Western Europe index makes little sense. What’s more, insofar as people are trading the iTraxx index, they are very unlikely to delta-hedge in the bond market — they’re just taking positions for a few hours or days, trading in and out. Blaming the iTraxx index for Greece’s problems makes no more sense than blaming the ABX index for the subprime crisis: it’s a symptom, not a cause.

But by far the worst part of the NYT piece is its headline: at no point in the article does it come close to making the case that banks in general, or Goldman Sachs in particular, are betting on a Greek default. At worst, banks are hedging their large exposure to Greece and other PIGS nations using an index they helped to create. But the fact is that Greece’s financing burden — the title of the NYT webpage is “Trades in Greek Debt Add to Country’s Financing Burden” — is entirely its own making. Blaming the banks here makes no sense at all.


JCH1952, what an odd thing to say!

“They did not have the funds because of the collateral arrangements in the CDS contracts. In terms of likely defaults, they probably did have the funds.”

JCH1952, AIG still owes the United States a bit more than $100 billion dollars in bailouts, including $70 billion in loans and interest, and $35 billion in relation to collateral the government accepted that proved to have a far lower market value.

If they have money somewhere, why don’t they pay it back? The answer of course is that they are broke. They are selling off their crown jewels and still can only pay a fraction of what they owe.

You are right that the collateral arrangements created an immediate liquidity crisis, but we have seen that many of those mortgage-backed securities really were worthless. Goldman and others wanted to be paid immediately because they saw or suspected that behind the facade AIG was insolvent, and they were right. They wanted to jump to the head of the line, before bankruptcy reduced their claim.

Indeed the default rate on subprime adjustable MBS has been running at close to 40% and rising! So these weren’t just paper losses! These MBSs have really been defaulting massively. Even prime fixed mortgages are defaulting massively.

Posted by DanHess | Report as abusive

Pricing kindle nonfiction

Felix Salmon
Feb 25, 2010 15:14 UTC

Yves Smith, of Naked Capitalism, has sent me a note to tell me how unhappy she is about the kindle pricing of her new book, which has a cover price of $30, an Amazon price of $19.80, and a kindle price of $16.50. Her publisher, Palgrave, is part of Macmillan, which just won a fight to force Amazon to sell e-books at more than $10, but part of the fallout from that fight is that books which cost much more than that on the kindle often get one-star reviews on the basis of their pricing alone.

Writes Yves:

You know my base skews heavily toward the type that buys on Amazon, and to top that off, as you would imagine, my book promotion is going to be more than usually web oriented, so that will maintain that skew.

I don’t know about you, but the vast majority of the time, if I see a book with an Amazon rating of fewer than four stars, I won’t buy it. And it does not take many one stars to drag an average down.

In principle, my sympathies are with Yves and Amazon here. Amazon wants to subsidize her book; she wants Amazon to subsidize her book; but her publisher, worried about kindle sales cannibalizing hardback sales, won’t let that happen, and is willing to risk bad reviews as a consequence.

My feeling here is that none of this matters a great deal. And the main reason is pretty simple: after about a year of kindle ownership, I’ve come to the clear conclusion that it simply isn’t suited for reading the vast majority of non-fiction. You might not even notice it when you’re doing it, but when you read a non-fiction work like this one, you tend to flick backwards and forwards a lot, skim past the bits you already know about, re-read earlier passages in light of later ones, that sort of thing. And that’s prohibitively difficult with the kindle, which is designed primarily for reading narratives where you start at the beginning and make your way steadily to the end. Truly narrative non-fiction a la Krakauer is fine, but “learn about the crisis” nonfiction just doesn’t lend itself to being read on the kindle at any price. If you’re the kind of person who reads footnotes, you will get very annoyed very quickly with the kindle whenever they start appearing.

What’s more, the phenomenon of angry one-star reviews will I think fade away pretty quickly: they’re a response to the change in prices more than they are a response to the price itself. If the price for a kindle book goes up from $10 to $17 without the product changing at all, that’s annoying. But if it was never $10 to begin with, the annoyance is much lower.

Obviously, the number of kindle versions of Econned sold will be lower at $16.50 than it would be at $9.99 — just as I doubt many people buy kindle versions of books which are more expensive than the ink-on-paper versions. But a substantial proportion of the people who would have bought at $9.99 but won’t buy at $16.50 are people who will now just buy the hardback instead — and I’m pretty sure they’re going to have a better experience that way. And that should make Yves happy, not angry.


For context, the list price of the hardcover is $30. BN.com has an ‘online price’ of $24, but ‘members’ pay $21.60, and at the moment non-members can get the member price.

Borders’ website has it at list price ($30).

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Felix Salmon
Feb 25, 2010 05:28 UTC

Aaargh! The Obama administration is no longer insisting on the creation of a stand-alone consumer protection agency — Wapo

Eric Jackson on how Goldman should beef up its board — The Street

So Long, Hummer! — Awl


“The Obama administration is no longer insisting on the creation of a stand-alone consumer protection agency”

Did they ever insist? Do they ever insist about anything?

Posted by jonhendry | Report as abusive

Has Corker killed the CFPA?

Felix Salmon
Feb 24, 2010 19:58 UTC

The single biggest question hanging over the future of financial reform in the US right now is what exactly is acceptable to Bob Corker in terms of a Consumer Financial Protection Agency. Bloggers on the left are pessimistic: Simon Johnson says that “the consumer protection agency is likely to be gutted as the price of bringing Senator Corker on board”, while Tim Fernholz says that bringing Corker along could “cost the Democrats key provisions in the bill — most notably, an independent Consumer Financial Protection Agency”.

But now Taylor Griffin and Tony Fratto are finally spreading what seems like pretty concrete intelligence on the form that the Dodd-Corker compromise is likely to take, in the wake of a weekend trip that the two of them took to Central America.

The contours of the Dodd/Corker deal look like this: an independent agency with its own source of funding would be established to regulate all federally chartered banks. The agency would have two divisions: one to conduct prudential regulation and one for consumer protection. The agency’s director would decide disputes between the divisions.

We could see this arrangement picking up enough GOP votes to get through the Senate, the big question will be whether this is going to pass muster with an Administration and House Financial Services Committee Chairman who have insisted on a “stand alone” CFPA. This is not completely stand alone, but it’s closer to that description than some of the other compromise proposals.

I’m not entirely clear what this means, but it seems, on its face, to imply that the FDIC, OTS, and OCC will all be combined into one agency, which would then have somewhat conflicting goals, when it comes to the zero-sum tug-of-war between banks and consumers. On the one hand, it would be responsible for ensuring that banks are profitable and well-capitalized; on the other hand, it would be responsible for ensuring that banks don’t gouge consumers in their search for adequate profits.

Most worryingly, the consumer-protection part of the agency would only seem to have control over federally chartered banks. That’s a very bad idea indeed, since it’s precisely the non-bank financial institutions — subprime lenders, payday lenders, non-bank credit card companies, Walmart, etc etc — which need as much if not more regulation, from a consumer protection point of view, as the banks.

And to top it all off, Griffin and Fratto write that even if a Senate compromise passes, it could still be derailed by Barney Frank when it comes to reconciling the House and Senate bills.

So, there’s no good news here, I’m afraid. And I’m inclined to agree with Fernholz that if working with Corker means losing the guts of the CFPA, it’s best to ditch him altogether and just try to push something through the Senate with the support of Democrats alone.


It’s looking like there will be no new laws. It seems like America is basically stuck with whatever laws are on the books now. Does that render America ungovernable?

Actually I don’t think so. US Code is already millions of lines long. I have no idea of everything that is in there but surely there are things for everybody!

From where I sit, the problem was never the laws on the books but the enforcement and the ethics of the banks. In the realm of liar loans and misleading loan bundlings, there could be fraud convictions galore. Banks should lose their charters over that. What else? Let’s see, simple fraud, securities fraud times 1000 (front running, false reporting, pump-and-dump or pump-and-short a-la Goldman and MBS), mortgage fraud, fraud related to credit default swaps not backed by an ability to pay, fraud related to so-called currency swaps with foreign governments based on falsified “historical” exchange rates.

The administration has completely taken its eye off the ball. The biggest wave of financial crime in history has just occurred and it is enforcement time. After the Savings and Loan Crisis, hundreds went to prison. The recent crime wave has been much larger. The biggest shock of all is the complete absence of enforcement. A few tens of billions spent on prosecutions would surely by money well-spent.

Surely after a robust round of prosecutions, the level of ethics will rise nicely. Trust me, nothing would do more to boost the standings of pols than the sense that America is still fair.

Truly, if existing laws cannot be enforced, what is the point of even one new law?

Posted by DanHess | Report as abusive

Housing: Still very shaky

Felix Salmon
Feb 24, 2010 15:01 UTC

I’ve been following the CoreLogic data on the number of underwater mortgages for over three years now, and it’s undoubtedly the most reliable time series we have on that front. Which is why this is so scary:

First American CoreLogic, the research firm that monitors housing equity, reported Tuesday that 11.3 million homeowners — or 24% of all homes with mortgages — were underwater as of the end of 2009. That’s up from 23% and 10.7 million borrowers three month earlier.

How could the number of underwater homeowners could have risen by 600,000 in just one quarter — especially when the latest Case-Shiller data shows national house prices more or less stable over those three months? I think the answer might lie in the seasonal adjustments: to take a couple of the more extreme examples, Dallas prices fell 0.9% on a non seasonally adjusted basis, while rising 0.1% on a seasonally adjusted basis, while Chicago fell 1.6% in nominal terms but only by 0.6% in seasonally-adjusted terms.

The biggest systemic risk posed by underwater mortgages, of course, is the fact that they’re much more likely to default. But if the decline in the value of your house is a cyclical, seasonal thing, then that’s clearly much better than if it’s likely to persist indefinitely.

On the other hand, we’re clearly in uncharted territory here — at the upper echelons of the credit scale, unsecured credit-card debt now carries a significantly lower default rate than secured mortgage debt. If the number of underwater homeowners is going up at the same time as the societal mores urging full mortgage repayment erode, then the ingredients for another real-estate bust are definitely in place.


“If the number of underwater homeowners is going up at the same time as the societal mores urging full mortgage repayment erode, then the ingredients for another real-estate bust are definitely in place.”

It’s not about another real-estate bust. It’s the same bubble as before, who’s been morphing and collapsing in slow motion over two years rather than in one bang – The result of trillions of taxpayers’ dollars pumped into it.

Posted by yr2009 | Report as abusive


Felix Salmon
Feb 24, 2010 14:21 UTC

A wonderful meditation on terroir — Doon

“Young women are the market of the future, although it’s sad if they’re especially attracted to shiny floaty gold flakes” — Wine Economist

Kwak dismantles JP Morgan’s small-biz lending claims — Baseline Scenario

Are your piles of platinum problematic? — Dotgif

Michael Kinsley enters the Magazine Editors’ Hall of Fame next month. And, Michael Lewis dedicates his new book to him! — ASME

Arts on the chopping block again at Brandeis, as school threatens to close theater design department — Daily News Tribune

Psychedelic kitty — YouTube

HSX goes real-money

Felix Salmon
Feb 24, 2010 00:13 UTC

Lauren Hatch mentions that the Hollywood Stock Exchange, which is to begin real-money trading on April 20, “has been just-for-fun since 1998″. What she doesn’t mention is that the company was sold to Cantor Fitzgerald with the express intention of turning it into a real-money exchange all the way back in 2001; it’s taken nine years to get the requisite permissions.

So while I’m happy to see a real-money prediction market finally get up and running on a fully-legal basis in the United States, it seems the barriers to entry in this business are so enormous that even Cantor Fitzgerald would probably not have bothered had they known what a hassle it would be.

A lot of the details about the new exchange remain unclear, including the degree to which it’s going to be accessible to ordinary punters as opposed to sophisticated investors. Whatever happens, its mechanism for returning money to participants can’t be worse than InTrade’s.


I’m a bit of a movie fanatic. As such, back in the day one of my favorite websites was Hollywood Stock Exchange (HSX). On it, you bought and sold both movies (moviestocks) and movie stars (starbonds) based on how you thought they would do with upcoming releases. Of course, all of this was done with virtual cash (H bucks), making it a fun game. But in April, the game turns real. As in, real money.make money in minutes

Posted by veerok | Report as abusive

Monoline datapoint of the day

Felix Salmon
Feb 24, 2010 00:00 UTC

Bloomberg reports:

Ambac, MBIA Inc. and Assured Guaranty, the three largest bond insurers, have set aside 0.04 percent of the total public finance debt they insure, or $520 million, to pay claims on municipal securities, according to regulatory filings by the companies.

No, that’s not a misprint: the claims-paying reserves are 4 basis points of the total quantity of municipal bonds insured. What’s more, the market capitalization of all three monolines combined is less than $5 billion; the amount of municipal bonds insured, by contrast, is well over $1 trillion.

What could possibly go wrong?

Update: MBIA’s Kevin Brown emails to point out that loss reserves are not the same thing as total claims-paying resources, which are $5.5 billion at National Public Finance Guarantee, the muni arm of MBIA. That’s about 1.1% of its insured bonds.


Point taken – Some mono-line insurance may be overextended; but Mr. Salmon may want to cite different statistics if this is something he wishes to prove.

1. The trillion+ figure that is mentioned refers to the maturity or face value of insured bonds in the municipal marketplace.
a. Most muni bond insurance does not pay face value instantly in event of default. It is primarily designed to make payments until the issuer (the municipality) can resume payments. Therefore, because the one trillion+ of bonds represents varied maturity dates spread out over decadesthe debt burden on the mono-line insurers, even if the entire insured muni market somehow managed to default at the same time (the chance of this is a staggering improbability) would not be a whopping 1 trillion all at once.
b. We are talking about three, albeit the three largest, insurers. This does not represent all mono-line insurers.

2. Market Capitilization? Completely irrelevant. Private companies, for an extreme example, have a market capitlization of $0. Market cap is most commonly the combined value of a company’s common stock oustanding. This figure has little to nothing to do with the viability of a bond insurer, their reserves, or the amount of debt that they insure. Further, an insurance company’s reserves could be above or below their market capitalization, which depends on price movements, stock market conditions, etc. Connecting the safety of an insurance company to their market capitalization makes very little sense.

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