Are people still worried?

Sand

Right, lets discuss the secondary market and its effects on the DTCC figures.

Firstly, Beef - lets say you write a 5 billion CDS against Greek default and I buy it. If Greece defaults, you have to pay me 5 billion. Ignoring all other participants, net notional is 5 billion, all nicely recorded in the DTCC figures.

Then lets say Later10 wants to buy some CDS, so I sell him my side of the existing 5 billion CDS contract that you have written. Nothing has changed from your perspective. You still owe the holder of the CDS contract 5 billion, the net notional is still 5 billion in the DTCC figures.

Its also worth noting that the DTCC tracks transfers of contract ownership of existing contracts in its figures - check the assignments figures. And they also track the contracts traded non-electronically and later reported.

Seriously Beef, your claim that no one has any visibility of the Greek CDS market is nonsense. We've a really good idea of the scale of the issue.

The "Credit Crunch" was a problem because people had been misled, or had misled themselves, into thinking they had bought top quality bonds and then suddenly realised they had no idea of what they actually had bought or what its value should be. That is simply not the case with Greek bonds and the CDS on them - even if we follow your logic of ignoring the information we know and presuming theres some dark and evil monster hiding under the bed in the shape of unreported contracts, you can be sure of two things: every counterparty knows the number of contracts they have written and they know the number of contracts they have purchased, and they know who has written them so they can very quickly report and claim their exposure in the event of a default - this is not credit crunch territory.

What would be incredibly de-stabilising would be a retroactive attempt to cancel or rule out CDS triggers in the event of default. Thats when a 5 billion dollar problem would turn into a total ****storm as the entire European CDS market collapsed.

I pointed out that we simply don't have the data, and the markets don't have the data, which could itself create a self fulfilling prophecy.

Right, discounting that we actually do have very solid data youre supporting a highly destabilising and dangerous policy by the ECB/EU based on no meaningful data whatsoever?

There seems to be a certain bias there.

@Later10

While gross notional amounts are obviously exaggerated figures for CDS, if street trades are concentrated to specific dealers, then the gross notional amount does actually gain relevance.

No, not in the way you seem to think it does. As I demonstrated with my earlier example, if Beef is the only writer of CDS, then gross notional and net notional will be the same. Similarly, if the market is concentrated, then that is also captured by the net notional figures.

Net notional tracks the net amount that needs to be transferred from losers to winners to settle all claims. Net notional is very small compared to the total gross contracts because people who sell CDS also buy them so in a default their gains offset their losses at least partially.

My own biggest problem with your apparent dismissal of the CDS problem is the fact that should a restructuring occur, a restructuring of Irish and Portuguese, and perhaps Spanish debt could follow. So you cannot look at a Greek CDS call as an isolated event, you have to look at the CDS exposure to all PIGS.

And in an enviroment where banks and bondholders have valued their portfolios on the basis that CDS will trigger in such a restructuring, what effect would it have on contagion if restructuring was achieved in some sort of fashion whereby CDS would not be triggered?

Suddenly a massive revaluation of portfolios would have to occur as banks struggled to value contracts of suddenly dubious legal value and calculated probability of success in suing the ECB/EU and their CDS counterparties who would dishonour their contracts...what would that do for a credit crunch as everyone struggled to process the new enviroment and what their assets and liabilities were?

This is the insanity of ECB/EU policy. Theyre devoted to turning a small problem into a huge problem.

@Kippy

Somewhere along the line, one would think that the products mentions above have had some part to play in the collapses we have seen here and across europe.

CDS were widely blamed for the Greeks troubles back in 2009-10. To the point where the Bundesbank launched an investigation. They reported back that there was no evidence that CDS trading has undermined Greece in anyway. Greece was in trouble because Greece ran itself into the ground - CDS trading was a symptom of the problem, not a cause.

CDS are essentially a form of insurance. Some sell it, some buy it. Think how strange it would be if the government was to try attack people for selling car insurance, on the grounds it was causing car accidents. Thats essentially whats happening.

As small peripheral states, we in Ireland should be supporting CDS. It can only help Ireland sell bonds if bondholders are able to insure that debt against default. With the ECB/EU declaring war against CDS it reduces our chances of rejoining the bond market.

beeftotheheels

Sand wrote: »

Right, lets discuss the secondary market and its effects on the DTCC figures.

Firstly, Beef - lets say you write a 5 billion CDS against Greek default and I buy it. If Greece defaults, you have to pay me 5 billion. Ignoring all other participants, net notional is 5 billion, all nicely recorded in the DTCC figures.

No this is not, which is my point. The creation of an instrument is not a trade, and unless the parties to that created instrument intend to trade it they do not need, and will not put it in a depository, so no one, other than the parties to that transactions and their lawyers and advisors need ever know that the instrument exists. This is the key point I am trying to make.

If you are French Bank SA with a huge exposure to Greek debt and you realised too late that you had too much risk, if you bought a CDS the last thing you would want is for anyone to have visibility to the fact that you had been completely naked. So, either you would take out a CDS with an insurer who could guarantee that the CDS would never be traded (by underwriting their risks through other means or other derivatives), or you would use an instrument which was not technically a CDS but which was triggered by ISDA calling a default to avoid that visibility. The markets think that the French banks are over exposed to Greek debt, they have not priced in a naked exposure to the level we are seeing in the bond and CDS markets.

I've worked with derivatives, and they are hugely useful things, not least for their ability to allow one to effect a transaction without the markets having visibility, and this is precisely why they are so dangerous from the point of view of assessing where risks lie in a financial system.

Sand wrote: »

Seriously Beef, your claim that no one has any visibility of the Greek CDS market is nonsense. We've a really good idea of the scale of the issue.

Personal anecdote time. During the credit crisis I was involved in structuring a derivative transaction with 10 zeros. Using the derivative to reduce the markets' visibility to the substance of the transaction - the equity markets on one side, the bond markets on our side. If you managed to stumble across the Irish company's name (which was chosen at random) you would find that it doesn't file accounts because we set it up so it didn't have to. Outside the two parties and the advisers to the transaction no one has any visibility to it short of the regulator of the banking entity asking them outright did you enter into this transaction.

This is what we do, all the time, and nothing has changed, Central banks have no visibility because when you combine a hell of a lot of bright people, a lot of money, and a vested interest in keeping the markets in the dark then that is exactly the result you can achieve. I didn't ever advise on whether the transaction was good or bad, I simply structured it and part of my mandate was to mitigate any visibility.

Sand wrote: »

The "Credit Crunch" was a problem because people had been misled, or had misled themselves, into thinking they had bought top quality bonds and then suddenly realised they had no idea of what they actually had bought or what its value should be. That is simply not the case with Greek bonds and the CDS on them - even if we follow your logic of ignoring the information we know and presuming theres some dark and evil monster hiding under the bed in the shape of unreported contracts, you can be sure of two things: every counterparty knows the number of contracts they have written and they know the number of contracts they have purchased, and they know who has written them so they can very quickly report and claim their exposure in the event of a default - this is not credit crunch territory.

It is not enough that I, as a Greek bondholder, know who I entered into a CDS with. In order to avoid a credit crunch the markets need to know where the exposure lies. And like the Credit Crunch, if the markets do not know then they will freeze up as financials will hoard cash.

Sand wrote: »

What would be incredibly de-stabilising would be a retroactive attempt to cancel or rule out CDS triggers in the event of default. Thats when a 5 billion dollar problem would turn into a total ****storm as the entire European CDS market collapsed.

I never suggested doing this, I simply pointed out that we do not know the scale of the problem. If I thought for one minute that the size of the market was $5bn I would suggest it in the blink of an eye. But I don't.

Sand wrote: »

Right, discounting that we actually do have very solid data youre supporting a highly destabilising and dangerous policy by the ECB/EU based on no meaningful data whatsoever?

There seems to be a certain bias there.

Did we have any solid data that allowing Lehmans to collapse would have the consequences that it did? Did we have any data that the Credit crunch would take out AIG (as a result of, it must be noted, these very instruments that you are lauding)? I am suggesting that the regulators and Central banks get this data, but until they do experience suggests that they should be cautious.

Sand wrote: »

And in an enviroment where banks and bondholders have valued their portfolios on the basis that CDS will trigger in such a restructuring, what effect would it have on contagion if restructuring was achieved in some sort of fashion whereby CDS would not be triggered.

1. Since no one will have passed on all the risk through CDSs there will be latent risk in any Greek lenders, and
2. Under current accounting rules this would be illegal because until Greece defaults, and while there is significant doubt as to when any default would arise and how any default would be structured any provision would be way too vague to meet accounting rules. Plus there is no incentive for banks going through Basle III and stress tests to book losses at this time that they might not realise, or at least not for the time being.

One final note. If you really believe that CDSs are simply a form of insurance, and that Greece will default, does it not strike you as odd that with several hundred billion of Greek debt out there that there is, in your view, an insurance market whose maximum exposure is a paltry €5bn? Surely that doesn't suggest an efficient market (or else suggests flawed data)?

rumour

Thanks for an informative post. However it does give rise to the question that if enough people like yourself know that there are quite a few less than visible transactions that have taken place to minimise visibility of risk, then to some extent the 'cat is out of the bag'.
The inability to quantify the sums involved only adds to uncertainty hence all the market reaction. Speculation feeds on uncertainty and given the only current example is lehmans doomsday scenario's in my view cannot be written off lightly.

Is it possible to get a grip of these deliberately opaque transactions? If not are we not headed for continued uncertainty.

beeftotheheels

rumour wrote: »

Thanks for an informative post. However it does give rise to the question that if enough people like yourself know that there are quite a few less than visible transactions that have taken place to minimise visibility of risk, then to some extent the 'cat is out of the bag'.
The inability to quantify the sums involved only adds to uncertainty hence all the market reaction. Speculation feeds on uncertainty and given the only current example is lehmans doomsday scenario's in my view cannot be written off lightly.

Is it possible to get a grip of these deliberately opaque transactions? If not are we not headed for continued uncertainty.

Well, my answer would be that we cannot ban them, because to ban them would require us to define them, and once you define something then, given a certain mindset, the easiest thing in the world is to structure to achieve a certain result while avoiding falling into that definition. And when I'm at work that is my mindset, which many others share.

However, whilst many market participants have a vested interest in keeping the markets in the dark, they don't have the same interests in keeping central bankers/ regulators in the dark. It would be difficult to justify structuring something to avoid having to tell a central bank about it unless there was evidence that that central bank leaked information to the markets.

So I would propose new reporting rules, principles based as with European accounting standards rather than rules based as with the US standards. We create new rules tomorrow which force Banks, Insurers, anyone in the real economy to notify the ECB/ local Central bank, of any risk diversification contracts with an aggregate value exceeding €1bn that they enter into (with the broadest possible interpretation of "risk diversification"). That way, we can ensure that the ECB has visibility as to where the risk lies/ what size the risk is. But the crucial thing is that such rules would need to be global, because if the Eurozone had such rules, and the US didn't, we'd still be in the dark on the US position.

I think hedge funds are different, post LTCM they generally don't get too big to fail, so I wouldn't force them to report, but that said they could create the next crisis, I'm only thinking about how to protect ourselves from a rerun of this one.

Sand

@beef

so no one, other than the parties to that transactions and their lawyers and advisors need ever know that the instrument exists. This is the key point I am trying to make.

Okay, so lets cover the key points here:

1 - We have a huge source of data on all reported Greek CDS in the market - and all Greek CDS must be reported. Net effect is 5 billion. All banks must report their Greek CDS to this market. Youre dismissing this as irrelevant when it comes to determining a course of action.

2 - You propose, paradoxically due to a lack of evidence, that the unreported CDS market is some huge lurking monster sitting out in the darkness waiting to pounce. Its effectively the flying teapot view.

3 - For these unreported CDS to be significant, I presume you propose that unreported Greek CDS in circulation must be at least 100 times the scale of reported Greek CDS. So circa 7,800 billion in Greek CDS being written but not reported.

4 - Because of this hunch which is derived from discounting known information and significantly weighting unproven hunches, youre supporting an intensely dangerous and destabilising policy pursued by the ECB/EU.

And you describe this as the cautious approach...

Just so we're clear.

If you are French Bank SA with a huge exposure to Greek debt and you realised too late that you had too much risk, if you bought a CDS the last thing you would want is for anyone to have visibility to the fact that you had been completely naked. So, either you would take out a CDS with an insurer who could guarantee that the CDS would never be traded (by underwriting their risks through other means or other derivatives), or you would use an instrument which was not technically a CDS but which was triggered by ISDA calling a default to avoid that visibility. The markets think that the French banks are over exposed to Greek debt, they have not priced in a naked exposure to the level we are seeing in the bond and CDS markets.

In the example you are describing, the French Bank would actually want to advertise that they had hedged their huge exposure to Greek debt. Why wouldnt they want people to know their huge Greek debt holding wasnt insured by CDS?

They might have wanted to hide their original greek debt exposure, but hiding the insurance of the greek debt from default (reducing their risk) is something they would be shouting about from the rooftops.

What youd properly be more worried about is a French bank which is busily selling hundreds of billions of Greek CDS insurance to anyone and everyone and which doesnt hedge its risk at all despite *everyone* knowing a Greek default is inevitable. And despite Greek situation having got to the point where no one can afford or needs to buy Greek CDS anymore.

Personal anecdote time. During the credit crisis I was involved in structuring a derivative transaction with 10 zeros. Using the derivative to reduce the markets' visibility to the substance of the transaction - the equity markets on one side, the bond markets on our side. If you managed to stumble across the Irish company's name (which was chosen at random) you would find that it doesn't file accounts because we set it up so it didn't have to. Outside the two parties and the advisers to the transaction no one has any visibility to it short of the regulator of the banking entity asking them outright did you enter into this transaction.

This is what we do, all the time, and nothing has changed, Central banks have no visibility because when you combine a hell of a lot of bright people, a lot of money, and a vested interest in keeping the markets in the dark then that is exactly the result you can achieve. I didn't ever advise on whether the transaction was good or bad, I simply structured it and part of my mandate was to mitigate any visibility.

It doesnt matter if the Central Bank has visibility of it or not. This isnt Soviet Russia - there is no central financial planning. Here is the worst case scenario:

1 - Greece defaults
2 - Greek CDS trigger. Claims are presented to each insurer.
3 - A net figure of 5 billion transfers throughout the entire world. Banks laugh off the CDS hit - the Greek debt writeoff is the real pain.
4 - Your unreported doomsday contracts trigger. Claims are presented to each insurer. Lets assume 500 billion transfers globally to make it appropriately scary.
5 - Banks fail or dont fail as a result of doomsday contracts.
6 - Governments step in to either rescue banks or not as they choose.

Situation is very clear almost immediately. Banks very quickly know what the effects of the hits were. A

The problem with the credit crunch was they didnt know what the collapse in the subprime market meant for them or their counterparties because they had hidden their subprime exposure in top rated bonds.

And a personal anecdote of mine: When Lehmans went down, our head was called in next morning for a crisis meeting. He was asked what our exposure was to Lehmans and to other counterparties. He couldnt actually say.

Guess what became the priority, and what remains the priority of every single bank out there? Everyone makes it their bussiness to know the risk they are taking on, especially with regard to the Greek market - the fact you cant even insure Greek debt anymore at any sensible terms demonstrates that.

I never suggested doing this, I simply pointed out that we do not know the scale of the problem.

Thats the ECB policy - it will only allow a restructuring of Greek debt if it wont trigger Greek CDS.

In order to avoid a credit crunch the markets need to know where the exposure lies. And like the Credit Crunch, if the markets do not know then they will freeze up as financials will hoard cash.

As I noted above, people will know within a few hours of a Greek default of where the exposure lies as contracts will be triggered practically immediately. There might (if we go with your view of reported contracts being a mere 1% of the total) be a bank failure or two with a required state rescue, but no credit crunch.

There isnt any grounds for a credit crunch here, unless the ECB gets its way, in which case the situation will be confused by long running court cases over dishonoured contracts.

Did we have any solid data that allowing Lehmans to collapse would have the consequences that it did? Did we have any data that the Credit crunch would take out AIG (as a result of, it must be noted, these very instruments that you are lauding)? I am suggesting that the regulators and Central banks get this data, but until they do experience suggests that they should be cautious.

Ah, if I recall it was a similar counsel of fear about the unknown and the unknowable that motivated the Guarantee decsion in 2008. The most cautious course of action (Keep every bank going, dont allow a bank failure, stop contagion....) turned out to be the most reckless.

In a similar fashion, ignoring what we know about the CDS market, and weighting only what we dont will lead to really bad decisions.

1. Since no one will have passed on all the risk through CDSs there will be latent risk in any Greek lenders, and
2. Under current accounting rules this would be illegal because until Greece defaults, and while there is significant doubt as to when any default would arise and how any default would be structured any provision would be way too vague to meet accounting rules. Plus there is no incentive for banks going through Basle III and stress tests to book losses at this time that they might not realise, or at least not for the time being.

1 - Of course, and CDS should help holders of Greek debt hedge their risk. Assuming of course the ECB doesnt get its way.

2 - I dont expect the CDS contracts to be considered valueless until they have been shown to be without value, with the necessary pre-condition of a Greek default being triggered.

No one will mark down their CDS positions just because the ECB/EU doesnt like them.

However, whilst many market participants have a vested interest in keeping the markets in the dark, they don't have the same interests in keeping central bankers/ regulators in the dark. It would be difficult to justify structuring something to avoid having to tell a central bank about it unless there was evidence that that central bank leaked information to the markets.

Sure there is - if the Central Bank/Regulators knew about your Doomsday contract they might arrest you, demand you unwind it, fine you or otherwise interfere with your brilliant trading strategy.

One final note. If you really believe that CDSs are simply a form of insurance, and that Greece will default, does it not strike you as odd that with several hundred billion of Greek debt out there that there is, in your view, an insurance market whose maximum exposure is a paltry €5bn? Surely that doesn't suggest an efficient market (or else suggests flawed data)?

No - people who are in the business of writing CDS contracts need to hedge their own risks too and the easiest way to do so is to buy insurance - the normal rules of sell high, buy cheap apply. And whatever about 2007-2008 we are in 2011 now and no one, apart from the ECB, runs up huge unhedged exposures to a basket case like Greece. For the contract to exist, it requires two participants: People might really want cheap insurance for Greek default right now, but times like these are just the time when sellers of insurance will not do so for anything less than ludicrous terms.

Hence it is completely unsurprising that the net notional is so small.

What would be intensely surprising would be some bank writing huge amounts of Greek CDS with no regard for the inevitability of Greek default. But only the ECB is taking that sort of risk.

beagle001

According to certain folk in the Dublin auctioneering establishments,we have turned a corner and now we have reached the bottom.

beeftotheheels

@Sand

1. We do not know the size of the CDS and other derivative markets, a fact which you seem to have grudgingly acknowledged. All CDSs are not reported to the DTCC, I don't know why you keep insisting that they are.

http://www.ecb.int/pub/pdf/other/creditdefaultswapsandcounterpartyrisk2009en.pdf

Fourth and most importantly, the scope of its data coverage is far smaller than for BIS data. In terms of products, basket CDSs or bespoke CDSs are to a large extent not covered, since bespoke contracts are not yet cleared by the DTCC. Its data coverage relates primarily to single-name, index and index tranche CDSs. A particularly pertinent example concerns American International Group Financial Products, the monolines and the CDPCs. These three types of CDS sellers are not respondents to the BIS survey and so are not captured by traditional reporting methods, which are tailored mainly to banks. However, the DTCC data would not have enabled this gap to be bridged, as those entities typically sold protection via bespoke contracts

2. I am simply supporting arguments for caution in the absence of evidence that there is no problem, learning the lessons from the Credit Crunch Mark I if you will.

3. Yup, a couple of hundred billion would probably do it, less if concentrated in the hands of fewer counter-parties, doesn't just have to be bespoke CDSs though, could also be any derivatives which directly or indirectly trigger from ISDA calling a default.

If Greece defaults, and triggers the CDSs then we could have exactly the right conditions for a credit crunch because no one knows where the ultimate risks lie. It will not be over in a day or two, in much the same way as we had CDO squared we have CDS squared and if the markets cannot identify where the ultimate risks lie, not just the credit risks but the counter-party risks then there is nothing to stop them freezing. They didn't know where the subprime risks lay in 2007, they don't know where the ultimate CDS risks lie now.

Lets play it out with just you, me, later10, Scofflaw and ei.sdraob as the parties. So, you hold 5bn of Greek debt and enter into a bespoke CDS with me. I'm getting nervous about having all this risk on my balance sheet (I'm not a huge insurer) so I manage to pass some of it along to Scofflaw (who's a hedge fund and so I really could not give a damn about him). All fine so far although I still have a lot of risk. But, ei.sdraob (he can be a manufacturing company) had borrowed 3bn off later10 (another bank like yourself). Later10 took out a CDS with me (some of the risk of which I passed along to Scofflaw). Greece defaults. You come looking for your, say €4bn off me and I look for some of it off Scofflaw. Later10 realises I'm exposed and looks at his own CDS - reassessing his counter party risk. I suffer a downgrade which causes Later10 an issue, he now needs to offload his CDS with me because he doesn't think it is worth much (I'm asking the taxpayers for money at this stage). ei.sdraob's debt is maturing and Later10 tells him he cannot roll it over because Later10 is hoarding cash due to the fact that he cannot get satisfactory CDS cover. And so it goes. A credit crunch.

Now, if we knew all of the risk was with Scofflaw then we'd be fine (sorry S), but we don't, and there are a load of interconnected risks here, and saying that because we cannot see them, or we can see a small proportion of them, justifies ignoring them strikes me as daft. There might be nothing we can do about them, you might be right on that. But to make a decision based on ill informed and incorrect figures is just wrong.

Had Big French Bank insured their risks when the bought the debt, or at the first sign of trouble in Greece then yes, they might have wanted to shout about it. But had they waited, until three months ago, then they would not want to shout about it because at that stage they wouldn't have been doing something clever (getting insurance), they'd have been undoing something dumb (not being insured) which would require admitting to being dumb - which Financials are never very keen on.

So, in the event that this happened I see nothing to suggest that Big French Bank would have done other than take out a bespoke CDS which the markets have no visibility to. However, the French Central Bank can know, and can feed this data on to the ECB, so for now I'm happy to let them do their job absent any evidence that they are not, in fact, doing the right thing.

Finally, you mentioned that a downside to reporting transactions to a regulator/ Central Bank is that they could fine you etc etc Since I have only ever worked with legal transactions and have never met a client who intentionally broke the law I don't see this as any disincentive. It is about as daft as suggesting that we don't try to gather data on household spending because some households are living on the proceeds of crime and so are likely to tell lies.

No business will jump at additional regulation, but there is not the same objective need to hide data from the Central Banks that there is to hiding it from the markets in many cases.

Sand

1. We do not know the size of the CDS and other derivative markets

Right...let me try explain this again. You have claimed that no one has any visibility Greek CDS market.

Lets say the Greek CDS market, Z, comprises of two sections. Reported, and unreported, X and Y.

Z = X+Y.

We know what X is. Less than 5 billion. Dollars. So less in Euro with the exchange rate. The only unknown figure is Y. Once we know Y, we know Z.

Given you are proposing Z is some crazy figure which will sink the gobal economy that means Y must be a figure which dwarfs X. What you are implying is that less than 1% of Greek CDS contracts in circulation are reported to the DTCC - the source of info on the Greek CDS market. This is at a time when the Greek CDS market is getting smaller and smaller and smaller, to the point where it has shut down because people are no longer willing to take on the risk of Greek default.

Apply some common sense here please when considering the probability that only 1% of contracts are reported to the DTCC, implying roughly 7,800 billion in issue. By comparison, theres a grand total of 470 billion greek sovereign debt. Including that held by the ECB and other institutional investors.

Even your own source notes that that the under-reporting is worst case in general terms no worse than 1-3, which would imply Y being no worse than 15 billion so Z is 20 billion. 20 billion isnt even enough to cover an Irish bank bailout...thats how small the CDS problem is. The real problem is and always has been the sovereign insolvency.

We have a really good handle on the Greek CDS problem. We can and should make decisions based on what we know, rather than what we dont. Otherwise nobody would get out of bed in the morning for fear of what they dont know might happen to them.

EDIT - For clarity: I think Y is a tiny fraction of X. As your own source notes, the only major discrepancy on reported contracts comes between non-dealers.

2. I am simply supporting arguments for caution in the absence of evidence that there is no problem, learning the lessons from the Credit Crunch Mark I if you will.

Youre fighting the last war. Fight the current one.

Your course is not the most cautious. Its simply ignoring what we know and what is probable and proposing a course of action based on what we dont know and what is improbable. You might as well propose jumping off a skyscraper because the lifts are out and we dont know there isnt a mugger hiding in the stairwell.

could also be any derivatives which directly or indirectly trigger from ISDA calling a default.

Not just any, they would have to specifically relate to a Greek default. There are insane people on the world but I sincerly doubt anyone would write such a broad derivative as you imagine without charging a price too hefty for anyone else to by willing to pay. People may have been surprised by the subprime crisis - no one is surprised by the Greek default. Except the ECB.

Thats the problem with your theory.

If Greece defaults, and triggers the CDSs then we could have exactly the right conditions for a credit crunch because no one knows where the ultimate risks lie. It will not be over in a day or two, in much the same way as we had CDO squared we have CDS squared and if the markets cannot identify where the ultimate risks lie,

"The markets" are not a cental hive mind. Theyre are hundreds, thousands or millions of agents pursuing their own agenda. Everyone will very quickly know where the ulimate risk lies because a few hours after the CDS trigger, the bills will be in the post. A kid with a calculator can figure things out from there.

Youre thinking of a situation where even you yourself didnt know your own exposure to subprime debt. Until you sat down and read through the fine print you didnt know what the hell it was you had actually bought. Nobody else knew their own situation either. Nobody knew how many subprime mortgages they held, or how they were performing, or how they were likely to perform once it was acknowledged they wouldnt pay out like investment grade bonds.

CDS on Greek Debt are vastly more simple. Everyone knows what their exposure to a Greek default is. Thats why the Greek CDS market has shut down. Thats why the net notional figures are "only" 5 billion. People are only willing to take a tiny level of risk on whats guaranteed as a near certainty. And that 5 billion is comprised of the people with the biggest brass balls or people who cant find anyone to buy their risk at a sensible level.

No one is willing to write them anymore, and no one wants to buy them at the going rate. And no one is willing to buy Greek sovereign debt.

Lets play it out with just you, me, later10, Scofflaw and ei.sdraob as the parties. So, you hold 5bn of Greek debt and enter into a bespoke CDS with me. I'm getting nervous about having all this risk on my balance sheet (I'm not a huge insurer) so I manage to pass some of it along to Scofflaw (who's a hedge fund and so I really could not give a damn about him). All fine so far although I still have a lot of risk. But, ei.sdraob (he can be a manufacturing company) had borrowed 3bn off later10 (another bank like yourself). Later10 took out a CDS with me (some of the risk of which I passed along to Scofflaw). Greece defaults. You come looking for your, say €4bn off me and I look for some of it off Scofflaw. Later10 realises I'm exposed and looks at his own CDS - reassessing his counter party risk. I suffer a downgrade which causes Later10 an issue, he now needs to offload his CDS with me because he doesn't think it is worth much (I'm asking the taxpayers for money at this stage). ei.sdraob's debt is maturing and Later10 tells him he cannot roll it over because Later10 is hoarding cash due to the fact that he cannot get satisfactory CDS cover. And so it goes. A credit crunch.

Theres only 2 banks in this equation.

Me: CDS save my bacon. I recover my losses on the Greek debt. Yay for me and my depositors/bond holders. Hooray for CDS.

Later10: His situation is pretty simple actually. As a worst case scenario, his cost is simply whatever it cost to reinsure ei.sdraobs debt, which is obviously a fraction of the debt itself. Which he only has to do if he distrusts your ability to pay, which he has no cause to do so should you pay me and remain in bussiness. Either you pay me and maintain your regulatory requirements, or you cant. Its very straightforward and very quick.

He also has to weigh your probability of default against the probability of ei.sdraob defaulting - ei.sdraob isnt you, and he isnt the greek sovereign. There is in fact no reason to prevent ei.sdraob rolling over his debt (which cancels the contract with you) unless he cannot otherwise insure ei.sdraob (who we can presume is a good bet for creditworthiness - thus relatively cheap to insure) and is unwilling to lend to him without it.

But to make a decision based on ill informed and incorrect figures is just wrong.

We have to make decisions based on what we know, and what we know about what we dont. And we know that the unreported CDS are at worst still inconsequential in the grand scheme of things. The biggest issue for a Greek default is going to be whose left holding Greek debt *without* CDS to save them - prime candidate is the ECB.

The ECB/EU is throwing around hundreds of billions, even trillions of euro and rapidly burning through political capital and goodwill toward the European project to save at worst 20 billion.

Finally, you mentioned that a downside to reporting transactions to a regulator/ Central Bank is that they could fine you etc etc Since I have only ever worked with legal transactions and have never met a client who intentionally broke the law I don't see this as any disincentive. It is about as daft as suggesting that we don't try to gather data on household spending because some households are living on the proceeds of crime and so are likely to tell lies.

I've never met a client who intentionally broke the law either - why would you need to when you have lawyers to redefine it? Apparently not a single Irish banker broke a single law over the past 10 years.

But perhaps you could explain the sort of client who wants to hide a transaction from the maket to prevent it being locked out of lending by more risk adverse market agents and yet would be so innocent and risk free that a regulator or central bank wouldnt freak out about it?

But had they waited, until three months ago, then they would not want to shout about it because at that stage they wouldn't have been doing something clever (getting insurance), they'd have been undoing something dumb (not being insured) which would require admitting to being dumb - which Financials are never very keen on.

Im still struggling to grasp why theyd prefer the markets to think they had a huge, unhedged, holding of Greek debt.

However, the French Central Bank can know, and can feed this data on to the ECB, so for now I'm happy to let them do their job absent any evidence that they are not, in fact, doing the right thing.

You know - Im sympathetic to this point of view. Back in simpler times, I actually believed that whilst there were certain risks in the economy that Irish banks would have them in hand - it was their risk afterall. And I reasoned that even if they didnt, the Financial Regulator would manage their risk for them by brute force restrictions. Sure, the fiscal and economic course was taking criticism from uninformed outsiders, but surely the DoF had the best access to all the info and thus they knew what they were doing.

So, I'm with you on the belief that surely, someone, somewhere must be out there like a wise shepard guiding the flock. They cant tell us what they know yet, but they know - their actions may seem foolish and self defeating, but its only because they know the truth and we dont yet. Its very comforting. We mightnt be able to understand why things are happening, but we can be reassured that everything is going according to plan. The DoF's plan. The ECB's plan. God's plan.

But from our own experience in Ireland, we have to allow for the very high probability that they havent a clue and their foolish, self defeating actions may be just that.

ei.sdraob

Hey look over there at the shiny $516 trillion derivatives market, its only 8x the world gdp there you see it? keep looking .. .. looks scary right??

Great now that you forgot about the insolvency problem in Greece (and Ireland)... move along nothing to see

beeftotheheels

@ Sand

So you now accept that we don't have visibility to the size of the CDS market, but maintain that we should still base our assumptions on your "top of the head" multiple of the net numbers (also wrong but given the time and energy it took to convince you that the numbers themselves did not give us any visibility to the size of the CDS market I'm not going to go there, gross is not right but neither is net in a market with more than 2 participants).

This also misses the point that the contagion issues goes well beyond CDS and other derivatives in respect of a Eurozone default, and again we don't have publicly available numbers on the three pesky little issues that are Belgium, Italy and Spain.

So, if the ECB chose to allow Member States pander to their local electorates, which is, remember, what closed the bond markets to us, and do nothing, then they would not be doing their job.

I also think it potentially defamatory to compare the ECB to the Irish Central Bank in the boom, there is no evidence that the ECB has been asleep on the job.

The ECB has taken a position, based on both the data which we can see and information available to Central Banks which is not necessarily published. And they were right in terms of this position previously so absent evidence to the contrary I am happy to trust them on this.

I also love that you assumed my client used a derivative to disguise the level of their indebtedness. Made me chuckle and goes back to the point that assumptions made without any evidence can be dangerously flawed. They were avoiding creating visibility that they were in the market for certain unquoted assets because that visibility would have impacted on the price they could get the assets for. Had the assets been quoted then there would have been visibility. But they weren't so we were perfectly free to structure as we did and I really don't see that having to tell a central bank about the transaction would have been a huge issue. The counter-party on the other hand were trying to avoid fessing up to the market as to how dumb they had been (Financials don't like doing this) by wanting to avoid giving visibility to the fact they were only then disposing of assets no longer (if ever) suitable for a bank.

So while I will accept that it is possible to avoid making any decisions in the absence of perfect data, the ECB is not avoiding making a decision, it is maintaining the position it has held for years now based on the data available to it combined with its experience of the markets.

So the ECB knows that there can be sharks in a particular stretch of water, it knows the behavior of sharks so it is warning bathers not to enter the water while continuing its study of sharks.

Your position is that absent any evidence that there are sharks in this particular stretch of water at this moment in time we should all dress up as seals and jump in.

ml.meriwether

This thread is hilarious. Nobody knows the internal dynamics of the CDS machine, but you can observe its strength from outside. A two stroke motorcycle engine is never going to fire an A380 aeroplane, it's a pretty simple concept.

There is no conceivable benefit for a desk which is dealing in CDS not to track its trades through optimisation programs. There is no conceivable benefit for a buyer of protection nor a seller of protection not to pass basic information on to the DTCC since all that the DTCC will publish are whole figures - figures whose magnitude all buyers and sellers of protection (through CDS, at least) will want to know.

I can't understand what's so difficult about this. Nobody seriously thinks there is a problem with Greek CDS - European CDS in general, yeah, sure - but Greece? The problem with Greece isn't their CDS, it's the principal outstanding.

beeftotheheels

ml.meriwether wrote: »

This thread is hilarious. Nobody knows the internal dynamics of the CDS machine, but you can observe its strength from outside. A two stroke motorcycle engine is never going to fire an A380 aeroplane, it's a pretty simple concept.

There is no conceivable benefit for a desk which is dealing in CDS not to track its trades through optimisation programs. There is no conceivable benefit for a buyer of protection nor a seller of protection not to pass basic information on to the DTCC since all that the DTCC will publish are whole figures - figures whose magnitude all buyers and sellers of protection (through CDS, at least) will want to know.

I can't understand what's so difficult about this. Nobody seriously thinks there is a problem with Greek CDS - European CDS in general, yeah, sure - but Greece? The problem with Greece isn't their CDS, it's the principal outstanding.

DTCC= depository
DTCC=/= data repository or regulator

My point throughout was that DTCC figures exclude bespoke contracts and why on earth would one report a bespoke contract to a depository who does not clear that contract and is not in the market of collecting and publishing data on contracts they don't clear, nor do they have any regulatory function to force the submission of that data (even if they wanted it, which they don't). DTCC are not a data repository, they are a CDS depository so they only care about the CDSs that they clear (which excludes bespoke contracts).

As we know from the credit crunch mark I that bespoke CDSs on CDOs and CLOs dwarfed the OTC CDS market, and took out AIG and the monolines which compounded the credit crunch due to the concentration of that market.

Hence I took issue with the ludicrous suggestion that the net DTCC numbers give the picture on Greek CDSs, let alone on the fallout from a Greek default because if there is another AIG or monoline out there insuring Greek debt (and insuring other debt) they will not be in the DTCC numbers while being very relevant to the likelihood of another credit crunch.

Leaving aside the impact on other Eurozone Member's debts, the balance sheets of the various banks, insurers, impacts on other CDS markets we actually do not know that this is a 2 stoke engine, take out one big insurer who is active in the CDS market on bonds and you'll undermine all the debt that they insure a la AIG and the monolines.

Money markets, bond markets, equity markets all have the jitters. Inter bank rates are heading up and Goldman's are pricing more risk into buy-out debt than other banks none of which fills me with hope that a Greek fall out will be the size that Sand was suggesting i.e. 5bn scattered to the four winds.

Of course it is not just the Greek CDS market, but we have no visibility of what the direct fallout of that first domino falling will be, let alone the indirect fall out.

Sand

You know, they could have just editted the post...

we have no visibility of what the direct fallout of that first domino falling will be

[abstract]You're wrong[/abstract]