Comments on: CDS demonization watch, central-clearing edition

By: JayTrader

JayTrader — Thu, 01 Mar 2012 14:33:45 +0000

Good Piece Felix-
Central Clearing is not a Panecea to what ails the Banking Sector. Its the rotten to the core balance sheets that are the problem. These banks need to open the Kimono so to speak and so far are unwilling to do so. They have skirted around openness and transparency via FASB regulations etc. There are only 2 ways to reign in the banks:
1-Bring down the leverage
2-Net Capital Rules.
This by itself will force bank balance sheets to shrink forcing the banks to get smaller.

By: pessimist2

pessimist2 — Thu, 01 Mar 2012 04:48:17 +0000

The big banks generally require collateral posting on trades like these. BRK’s index trades are not relevant.

Even if the trades on Greece are done without margin, which is just not plausible, I find it hard to get around the fact that net and gross notionals aren’t that big. 3b net and 70b gross isn’t going to be doing much to the global economy.

http://www.dtcc.com/products/derivserv/d ata_table_i.php?tbid=6

By: Btherm

Btherm — Thu, 01 Mar 2012 02:29:48 +0000

The comment by JayCM (above) and Coventry League’s blog titled “Derivatives: Collateral Posting Not Retroactive” are highly relevant. Some – many, evidently – continue the meme that CDS parties have already posted margin/collateral. Maybe; maybe not.

It depends on when the contracts were initiated and whether they are centrally cleared. If they were initiated, say, in early 2010, then ZERO collateral posting is required. Review Berkshire Hathaway’s $63B derivatives (note these are index derivatives). NONE require margin/collateral posting of the $10B+ that would be required if these contracts were initiated after mid-2010. This is just one small example.

As Coventry League said, we shall see…

By: streeteye

streeteye — Wed, 29 Feb 2012 23:01:31 +0000

Got to disagree about no one linking bank solvency to OTC derivatives. GS made a huge deal about being hedged with CDS against AIG. Maybe it was true, maybe not. If it was true, who knows who was on the other side of those trades and might have been taken down by a default. In the decision to blank-check AIG right after Lehman, derivatives and their impact on the system’s solvency were front and center. Even before that, there were a lot of concerns about whether the Lehman CDS would settle without a crisis. So, even though the CDS weren’t triggered for AIG and settled without major hiccups in other cases, OTC derivatives added a great deal to uncertainty about bank solvency. Central clearing and reliable exposure data would have mitigated that.

By: pessimist2

pessimist2 — Wed, 29 Feb 2012 22:56:15 +0000

That is super what the G20 said, but that has nothing to do with Greece CDS. Greek CDS are a mess but that is mostly due to issues of deliverables and the bond swap.

The notionals are small, and the trades are typically collateralized. Can you point to anything that would make us think CDS will lead us a systemic meltdown?

By: petereavisNYT

petereavisNYT — Wed, 29 Feb 2012 22:48:52 +0000

Also, for reference, here’s what the G20 said in 2009, clearing fingering certain OTC derivatives as systemically risky:

“The recent financial crisis exposed weaknesses in the structure of the over-the-counter (OTC) derivatives markets that had contributed to the build-up of systemic risk. While markets in certain OTC derivatives asset classes continued to function well throughout the crisis, the crisis demonstrated the potential for contagion arising from the interconnectedness of OTC derivatives market participants and the limited transparency of counterparty relationships.

OTC derivatives benefit financial markets and the wider economy by improving the pricing of risk, adding to liquidity, and helping market participants manage their respective risks. However, it is important to address the weaknesses in these markets which exacerbated the financial crisis. To this end, building on the commitments set out in the Pittsburgh statement, the G-20 Leaders committed at the subsequent Toronto Summit to accelerate the implementation of strong measures to improve transparency and regulatory oversight of OTC derivatives in an internationally consistent and non-discriminatory way.”

By: pessimist2

pessimist2 — Wed, 29 Feb 2012 22:46:33 +0000

Eavis’s comment is completely vacuous. At no point in his rambling, incoherent response was he even close to anything that could be considered a rational thought. Everyone in this chatroom is now dumber for having listened to it.

By: JayCM

JayCM — Wed, 29 Feb 2012 22:46:09 +0000

Are you sure there aren’t some 5-10 year old CDS exposures written back when people thought a Eurozone default was implausible?

My impressions of the CDS market were 1) it’s huge, 2) it mostly nets to zero, and 3)it’s so huge that even small percentage deviations from perfection have trillion-dollar consequences. Am I wrong here?

By: Greycap

Greycap — Wed, 29 Feb 2012 22:25:28 +0000

Judging by his comment here, you have been rather too kind to Mr. Avis.

By: petereavisNYT

petereavisNYT — Wed, 29 Feb 2012 21:44:46 +0000

Felix,
Thanks for discussing my story. I think you underestimate the importance of central clearing. Bank solvency and strength is hard for outsiders to gauge when non-centrally-cleared OTC derivatives make up a large part of the balance sheets of large, interconnected financial firms. If the Fed and other central banks hadn’t flooded the system with money in 2008, OTC derivatives could have caused far more damage than they did, so it makes no sense for some people to say that just AIG was the problem. Hence, the G20 was correct to make central clearing a priority in 2009. Now we are on the verge of large default, it makes perfect sense to link central clearing to (Greek) CDS. Will activating them lead to a systemic meltdown? There are no visible signs that will happen. But it seems reasonable to have expected central clearing to be in place by now. If it were, we wouldn’t have to just sit here and hope that the banks are sufficiently collateralized because they say they are. Financial regulation done well allows regular people not to have to take big banks at their word. It also protects the system against risks you can’t currently see. Europe may not be through with sovereign defaults. The Greek one has been stressful enough. CDS would certainly – and deservedly — become an issue of Italy ends up struggling under its debtload. So we should expect the system to be as girded as possible, especially three years after the 2008 crisis. Linking all this together hardly deserves the adjective “demonization,” my friend.
Best,
Peter

By: realist50

realist50 — Wed, 29 Feb 2012 19:00:47 +0000

Great points by Felix. Analogous to how the recent financial crisis was far from the first banking crisis triggered by the crash after a debt-fueled run-up in real estate prices, despite what a lot of commentators say.

By: anonhfm

anonhfm — Wed, 29 Feb 2012 17:20:55 +0000

Hear, hear. If there were any risk from Greece CDS it would be from its NOT trigger. Everyone has posted collateral to a 70 points upfront value. If it suddenly gapped to zero, *that* would be the riskier situation from a counterparty perspective. What’s more, if the market perceives that CDS does’t work, every bank’s reported sovereign exposure is unreliable. Talk about destabilizing! The only way to hedge sovereign exposure would be to sell sovereign bonds. Does the ECB want to really kick the SMP into high gear??