Bo Peng

VIX Nearing 20: Who Cares?

"In terms of volatility, we are right at the VIX’s lifetime moving average, which means investors are pricing in an average amount of risk and uncertainty – in historical terms – at the moment."

From the fundamental point of view, do you believe the current risk in the economic/financial system is right about the historical average over the past 20 years?

We're right in the middle of a bubble.

Is a Case of Quant Trading Sabotage About to Destroy Goldman Sachs?

"Co-located", with what? Must be the exchange order execution servers. Otherwise network latency alone could easily put you beyond the microsecond timescale.

In other words, GS prog trading orders don't go through the internet to reach the exchanges, but rather just one ethernet router away.

The physical proximity has to be a critical factor to achieving such extreme low-latency.

Is this legal? Does it raise any questions of unfair access or anti-competitive behavior? I don't know. But these could be interesting questions.

Is a Case of Quant Trading Sabotage About to Destroy Goldman Sachs?

Could the reason for GS stopping or at least scaling down their program trading be that they were concerned of potential legal inquiries if/when the secret of their system gets out?

My best guess is it's a massive front-running scheme, which doesn't have to be illegal if done with publicly available data.

What if Chrysler Holdouts Overhedged with CDS?

CorradoCam, I'm not sure how DTCC classifies ref entities. DaimlerChrysler papers are still traded but the current Chrysler loans are traded under "Chrysler Financial" and I have no idea the reason why it's not on the list is because it's not big enough, LCDS are not included in DTCC stats, or lumped under DaimlerChrysler for some reason.

hoffman23, people write CDS on Chrysler/AIG for short-term bets. It all depends on the price. It may look stupid in retrospect but there's a technical problem -- you can't trade in retrospect. In any case, trading wisdom of anyone is irrelevant.

Bo Peng suggests a simple way to eliminate the destructive positive feedback loop created by bondholders owning credit-default swaps on their debt: reduce their say in bankruptcy court by the value of the CDSs they own.

Hedging or taking risk has nothing to do with worthiness as a man or a woman. What I'm saying is that your say on the company should be proportional to your exposure, including hedging. What I did not say is that you could buy bond, then over-hedge with 200% CDS, then use your bond position in pre-restrucutring talks to minimize recovery, and get a windfall with CDS. As someone said in comments to my article, this is like buying a run-down building and insurance then burning down the building and claiming insurance.

Chrysler: Reshuffle the Corporate Capital Structure?

Thanks for the info, car_guy.

When you invest in a company, your valuation is based on all-in cost. So whether Fiat put the $2B cash upfront or later doesn't change the valuation. I think the $10B ballpark valuation for Chrysler still stands.

As to UAW's recovery, it's recovery for its "investment" in this deal, not its overall VEBA liability. So I think 55% recovery is correct. I'm not sure it was smart for UAW to accept the conversion of their junior debt into equity, though. It does carry a lot of risk. And now they're on the hook to lower their demand in contract negotiations. It's a no win situation for them.

Annihilate the Perverse Effect of CDS on Bondholders

George, I don't think the orderly unwinding of LTCM is the source of the problem. The problem is that Wall St learned from that lesson and lobbied hard for the bankruptcy code reform of 2005. They got their wishes, and became the wolves that devoured Bear, Lehman, and Merrill, and then went on life support themselves. You could almost call it poetic justice if the consequences weren't so dire and widespread.

Annihilate the Perverse Effect of CDS on Bondholders

viewfromnyc, you're right that the US corporate law emphasizes more on shareholder than, say, the German system that gives bondholders more weight. I'm not advocating any change at the philosophical level. There's no duty for the bondholder to "help" the company. If only to respect your effort of writing such long comments, I'd like to avoid diverging into other directions.

What I am advocating is the simplest, most common-sensical remedy of the disassociation of the normal economic interest created by modern hedging techniques. No need to bring in naked CDS buying. It's a separate topic by itself. Let's reiterate:

Set-up: You hold $1M bond. Company is in trouble.

Scenario A: You're unhedged. You have $1M worth of say in re-org/restructuring/b... negotiations. No problem there.

Scenario B: You're fully hedged with CDS -- how much premium you pay for it is irrelevant. Now you have 0 exposure. In fact, given the fact that the company is in trouble, it's better for you if the company defaults right away than going through some other remedies. But you still have $1M say in the negotiations. Of course you'll push for speedy default. This is a problem. While bondholder is not expected to help the company, she's not expected to push the company off the cliff, either, not in a system that's rational on the macroscopic level. The old system was mostly rational. With CDS and the bankruptcy code reform of 2005, the last inhibition is taken out.

Compare LTCM and Lehman. Back when LTCM was in trouble, all Wall St banks had their skin in the game. They pitched in and helped orderly unwind. In the end, everybody won in the sense that the economic loss turned out to be much less than a brute force shutdown, and the shock to the financial system was much smaller. When Lehman was in deep water, however, bankruptcy reform of 2005 had been in place. Derivatives counterparties got to cash out even through Chapter 11 protection. Furthermore, most big Lehman bond holders are well protected with CDS. As a direct result of this new dymanics, no big institutions had the incentive to help Lehman avoid bankruptcy. The end reuslt is a disastrous shock to the system, and a lot of retail bondholders got wiped out of their life savings.

If there were no 2005 reform, the other Wall St banks would've been incentized to at least help Lehman unwind orderly, much like LTCM. If the bondholder netotiation power had been allocated by the real economic interest after accounting for hedging, which would shut out many of the institutional bondholders and bring in net Lehman CDS sellers, at least everybody's interests would've been much better aligned.

U.S. Dollar Can and Will Drop

Everybody has her own investment philosophy. Mine is not to try to pick the top/bottom, but follow the trend.

I think USD will drop once the world economy stabilizes. In the interim it depends on the timing of events. The current rally is based on the premise that US economy will rebound ahead of Europe/Japan. But even if this turns out to be true, USD will drop once the cloud clears over Europe/Japan, which could easily be a year away.

That said, I'll let the market tell me what to do. Everybody knows about the Turtles by now. Even idiots can use it. But I'm not sure how many people really get it AND have the capacity to follow it.

Good luck!


On May 01 02:36 PM Just Say Whoa! wrote:

> >But I'll be ready to flip USD in short order going forward.
>
> What's the "BUY" indication?
>

Annihilate the Perverse Effect of CDS on Bondholders

viewfromnyc, I think you misunderstood what I was saying. I was not saying CDS seller should share the bond recovery. That would change the nature of the product. I was saying CDS seller takes on credit risk of the issuer while the buyer transfers out of the credit risk, therefore in bankruptcy court the bondholder's representation should reflect her real credit risk exposure after accounting for the hedge.

In normal times, bondholders of course would like to get coupon payments. In distressed situation, however, yield goes to 30% and bondholder is faced with the choice of taking the capital loss by selling on the secondary market or taking the significant default risk by holding on to the paper. In good'ol times, these are the only two choices. So she's very incentivized to help saving the company. Now she just buys CDS and, all of a sudden, bankruptcy becomes at worst a non-event, roughly equivalent to if the company spring back to health and bond goes back to par or if the company drags on in despair.

DIP financing used to be an important life saver for companies in Chapter 11. Shareholders used to aligned with the company. Now with hedging, people can have zero exposure, yet still retain their voting rights. This is absurd. Hedging is perfectly fine. It's the bankruptcy court and shareholder meetings that have fallen behind times and produced the absurdity.

U.S. Dollar Can and Will Drop

Not sure about supply destruction, Mashuri. The capacity in Germany, Japan, China, and Korea has been reduced, but not damaged, not unless the depression lasts a few more years. If inflation does surge as expected, it'd be due to pure monetary factors rather than supply and demand of goods/services.

U.S. Dollar Can and Will Drop

I'd like to add one point: as a commenter pointed out, USD devaluing is not all negative. It could stimulate jobs and export. But such a transition would require a fundamental transformation of global finance and trade, as well as the economic structure in the US. Abrupt changes would be disruptive and even destructive. After Fed's QE, the chance of abrupt USD devaluation some time within the next year or so has increased dramatically.

U.S. Dollar Can and Will Drop

Excellent analysis, Stephen. The race to the cliff -- competitive QE -- is just waiting for the sound of next shoe dropping.

In a way it's unfair to US. UK and Japan started it way earlier. But once Fed did it, now the moral inhibition against QE has disappeared. Instead of being the last resort, the world will consider QE the first choice when the next crisis trigger event hits, if only to protect their self-interest. A classic example of Prisoner's Dilemma.

Five Ways This Bubble May End

Ricard, I think I've answered your question of "bank fails then what" question before. I see that you're not convinced. ;>

Bank fails. Deposit is saved. Commercial banking part remains public if possible. Investment banking part is taken over by gov and then sold to private partners ASAP. We go back to the old Wall Street model that had worked quite well for about two centuries. Counterparty risk chain reaction is unlikely as demonstrated by the non-event of Lehman CDS settlement.

My point is, too big to fail means it's too big, therefore needs to be broken down. Instead, the gov (not just US gov) is making them even bigger.

China's First Step Towards Bilateral Currency Swaps

Stephen, good point on the potential competitive devaluation. But if it happens, for example triggered by Japan/Switzerland/ECB doing QE, I think USD would only strengthen before world economy stabilizes, for the same reason why USD has strengthened after the Fed's QE announcement. If Yuan still holds on to the dollar peg under this scenario, then it'd create some very intriguing dynamics.

USD will remain strong for the duration of the depression, even though JPY collapsing is a distinct possibility. I don't know for how much longer Japan can bear the pain. Their decision yesterday to do practically nothing was very surprising to me.