Credit Default Swap Resolution

The NY Times has an article on Credit Default Swaps and what should happen with them. Probably the most interesting quote is:

Mr. Raynes’s resolution is more radical: unwinding all outstanding credit-default swaps through a process he calls inversion.

Under this plan, insurance premiums would be refunded to buyers of credit protection from the entity that wrote the initial contract. And the seller would no longer be under any obligation to pay if a default occurred.

The premium repayments would be made over the same period and at the same rate that they were paid out. If a contract was struck three years ago and charged quarterly premiums, the premiums would then be refunded quarterly over the next three years.

Wouldn't this also create a reverse market as well? They'd be like 3 year bonds that could be traded and rated based on the health of the originator of the swap...

One of the funny things about the CDS market is that everyone gets so worked up about it because of the size of the market (Est: 30 Trillion $US). But the chances of payment on even a fraction of this is extremely remote. The larger problem with them is the psychological risk associated with the currently interwoven global economy; should an institution go bankrupt the carnage would not be contained to their own poor choices, but would be magnified (many times possibly) by forfeitures by CDS issuers, and then again by CDS insurers on Swaps in the orginal issuer, etc.. Seems like a freeze would help, but what is really needed is a new major bank that is decoupled from the other entities in this market and is able to operate freely without these liabilities. Hmmmm...

Yet another reason to keep on the lookout for the rise of community banks in your neighborhood. VC opportunities? We all know that there is some cash out there.

Michael Lewis Interview

On Journalism:

When I write a long magazine piece that gets attention I feel like it's more widely read now than it was ten years ago, by a long way. In fact, it feels excessively well read. Twenty years ago I might get a couple of notes in the mail and I'd hear about it maybe at a dinner party. And that would be the end of it, and it would go away very quickly. Ten years ago it would get passed around by email, and it would seem to have a life to me that would go on a little longer. Now the blogosphere picks it up and it becomes almost like a book: it lives for months. I'm getting responses to it for months. And I don't think the journalism has gotten any better.

Focusing on Value at Risk:

Lets take a bond, let's say a General Electric bond. A General Electric bond trades at some spread over treasuries. So let's say you get, I dunno, in normal times, 75 basis points over treasuries, or 100 basis points over Treasuries, over the equivalent maturity in Treasury bonds. So you get paid more investing in GE. And what does that represent? You get paid more because you're taking the risk that GE is going welsh on its debts. That the GE bond is going to default. So the bond market is already pricing the risk of owning General Electric bonds. So then these credit default swaps come along. Someone will sell you a credit default swap -- what enables the market is that it's cheaper than that 75 basis point spread -- and he's saying that in doing this he knows GE is less likely default than the bond market believes.

Why does he know that? Well, he doesn't know that. What really happened was that traders on Wall Street have the risk on their books measured by their bosses, by an abstruse formula called Value at Risk. And if you're a trader on Wall Street you will be paid more if your VaR is lower -- if you are supposedly taking less risk for any given level of profit that you generate. The firm will reward you for that.

And, turns out I don't agree with him on everything:

You know, I have yet to have a financial person persuade me that there's a really useful reason for a credit default swap. I know why they exist and I know why they're used. They're mostly used as speculative instruments. And the people who are selling the insurance are mostly selling it because they don't pay a price for it until everything goes bad. They weren't judged as taking any particular risk. But I have yet to have anybody explain to me why these things are terribly useful. They might have some good use and I just haven't heard it yet, but I'm dubious.

Default Swaps certainly are difficult to understand, and there is definitely risk associated with them. But they are instruments to enable investors to act on information or hedge other risks in their portfolio in a more effective and targeted way. The problems with them come from lack of accounting in risks and leverage/oversight by the people/markets who create them.

GE and Capital Crisis

Money quote from Times piece this PM:

G.E. said its finance arm overall should be able to earn $5 billion in 2009, despite assuming losses from bad loans totaling $10 billion mainly on credit cards in the United States, home mortgages in Britain and commercial lending to businesses.

Way back quote from Meredeth Whitney:

The U.S. credit card industry may pull back well over $2 trillion of lines over the next 18 months due to risk aversion and regulatory changes, leading to sharp declines in consumer spending, prominent banking analyst Meredith Whitney said.

They are just exposed from every possible direction.

David Swenson on Charlie Rose

He manages the Yale endowment.



He cites Ben Graham specifically as a mentor.

Where's the teeth, SEC?

Good article from The Big Money about the possible new head of the SEC:

Schapiro, who was first appointed as an SEC commissioner by Ronald Reagan in the late 1980s, has most recently presided over the FIRA —a nongovernmental regulatory agency dominated by industry participants that epitomizes the "self-regulatory" approach, according to which the financial industry is quite capable of overseeing its own affairs without interference by the state.

The whole piece reminded me of this piece by Michael Lewis in the NY Times:

If the S.E.C. is to restore its credibility as an investor protection agency, it should have some experienced, respected investors (which is not the same thing as investment bankers) as commissioners. President-elect Barack Obama should nominate at least one with a notable career investing capital, and another with experience uncovering corporate misconduct. As it happens, the most critical job, chief of enforcement, now has a perfect candidate, a civic-minded former investor with firsthand experience of the S.E.C.’s ineptitude: Harry Markopolos.

Mr. Markopolos is the guy who wrote a 17 page opus to the SEC speculating exactly what Bernie Madoff was, which they proceeded to ignore. It is worth reading simply to know how just how obtuse the SEC must have been not to catch Madoff, and just how much fixing they need. But it is beyond comprehension to me that this is the first that I have heard of this appointment, and that an Obama administration would choose her. It seems a basic qualification for any would-be head of the SEC should be: If you investigated Madoff and failed to find anything wrong, than you are disqualified.

Here's my choice. Why not?

Somalian Pirates

This story just gets more and more interesting (from the Independent):

In 1991, the government of Somalia collapsed. Its nine million people have been teetering on starvation ever since – and the ugliest forces in the Western world have seen this as a great opportunity to steal the country's food supply and dump our nuclear waste in their seas.

Yes: nuclear waste. As soon as the government was gone, mysterious European ships started appearing off the coast of Somalia, dumping vast barrels into the ocean. The coastal population began to sicken. At first they suffered strange rashes, nausea and malformed babies. Then, after the 2005 tsunami, hundreds of the dumped and leaking barrels washed up on shore. People began to suffer from radiation sickness, and more than 300 died.

Ahmedou Ould-Abdallah, the UN envoy to Somalia, tells me: "Somebody is dumping nuclear material here. There is also lead, and heavy metals such as cadmium and mercury – you name it." Much of it can be traced back to European
hospitals and factories, who seem to be passing it on to the Italian mafia to "dispose" of cheaply.

Yeah, thats right: The Mafia! More to come on this...

Too Beautiful to Live

I spend too much time in front of the computer, all things considered. Because (most) of that time is used productively (ahem) I tend to listen to things while I work, which is why podcasts have been such a lovely thing for me. And, I suppose because I have so much time to "screen" shows I feel like I have hit on a pretty good mix of podcasts, NPR and pandora (with some personal tunes thrown in for kicks.) I'll be glad to share more as I go along, but... Anyway, around Halloween time I heard a great segment on This American Life (sorta a weekly treat for my ears) from this show in Seattle "Too Beautiful to Live." I have been pretty much hooked since then. It is high brow enough that the maybe 30% of attention that I give to the show occasionally while it plays in the background allows me to hear an interesting nugget or two of information every hour or so, and I genuinely laugh out loud every other show. Also, it is conveniently on in three, one hour, podcasts so I can spread them out throughout the day. Anyway, they just got written up as the new wave of something good in Talk Radio. They are definitely going places, so give them a try and I think you'll like it.