Goldman, Morgan's CDS-Prime Broker Plan: Why I'm Skeptical

So Goldman (GS) and Morgan Stanley (MS) will determine the amount of credit they’ll grant their prime brokerage clients based on the value of credit defaults swaps on the banks themselves.

I see the logic, but am skeptical.

First, one of the lessons of the current crisis is that the CDS market can be hugely panic-prone—particularly when it comes to determining the creditworthiness of highly leveraged financial companies such as Goldman and Morgan. (If you doubt it, take a look at what's happened to the price of CDSs on Berkshire Hathaway.)  It doesn’t necessarily follow, then, that prime brokers should cut back on credit just because the CDS market is going through an anxiety attack unrelated to actual, deteriorating fundamentals.

Plus, this scheme runs risk of creating a potentially vicious negative-feedback loop, doesn’t it? Heightened anxiety in general leads to credit constraints, which leads to margin-related selling, which leads to more anxiety, and off you go. Pretty soon an imagined problem is transformed into actual one.

Terrific. . . . 

Comments

[anti-pb:]

MS will always screw their PB clients. Advice from a current employer.

2008 Aug 19 02:53 PM

[CrazyIvan:]

Actually, it is a positive-feedback loop that has negative consequences.
Positive feedback amplifies the initial perturbation -- as in nuclear fission.

2008 Aug 20 01:42 AM