Rakesh Saxena

Netting Derivatives: Slippery Slope Marred by Opaqueness

Dear oapoki: FYI I have been working with ISDA contracts for a very long time, and have reviewed hundreds of such contracts when closing derivative transaction, though I am not a lawyer by profession. If you have read any of these contracts with precision you will realize the point I am making: that where the shift in the fundamental nature of the contract towards "insurance driven" coverage did not fully capture the risks involved and the counterparty risk. I am not suggesting that such contracts should be abandoned. - Rakesh


On Mar 07 09:00 AM oapoki wrote:

> It is sad to see you guys commenting on these, admittedly complex
> issues, with no idea what you are talking about.
>
> Has any of view taken a look at an ISDA contract? Has any view used
> an ISDA contract in practices? Has any of view wlaked through the
> process of netting in a bankruptcy?
>
> I would simply state that "action talks and BS walks". It is not
> accidental the the derivatives industry has grown to these levels
> - they add value because they enables participants to hedge risks
> - even if people misuse thes einstruments (like everything else).
> In the absence of the ISDA agreement, with its associated actual
> netting (not imagined as the author contends) benefits (as we have
> seen in the case of Lehman), we would have chaos.
>
> ISDA contacts have proven to be extremely robust in the face of extreme
> conditions, and I hate to see what would have happened intheir absence.
>
>
> So be acreful what you are wishing for!

The Eurozone's Winter of Discontent Approaches Shakespearean Proportions

You are correct Sir. The East European situation wil get even more messy as we move along. - Rakesh


On Mar 01 11:11 PM The Mad Hedge Fund Trader wrote:

> Uh BBg While American banks have their subprime crisis, European
> banks are being dragged under by their lending to emerging economies
> in Eastern Europe. Ledd by UniCredit in Italy, Austria’s Erste Group
> Bank and Raiffeisen International, France’s Societe Generale, Belgium’s
> KBC, and Hungary’s OTP, banks have lent $1.6 trillion to companies
> in these formerly communist countries at cheap rates, with minimal
> documentation, and few questions asked. The easily available credit
> caused local money supplies to explode, and sparked bull markets
> in both stocks and currencies. Emerging Europe grew at rates double
> and triple rates in the West, as local companies pumped up on steroids
> became the master of leverage. Now $400-$600 billion is due for rollovers
> this year from nonexistent credit markets, and the chickens….make
> that vultures have come home to roost. Economic growth has fallen
> off a cliff, with Poland’s seasonally adjusted industrial output
> down in December a precipitous 7.4% YOY. The Polish stock market
> fell 48% last year, and the zloty of off 40% again the dollar from
> its June peak. The Central European Equity Fund (seekingalpha.com/symbo...)
> has crashed 80% in eight months. The crisis is so severe, it may
> postpone Poland’s entry into the Euro block, which had been scheduled
> for 2011. Home mortgage borrowers are in especially bad shape. Up
> to 50% of their loans were denominated in Swiss francs, so the collapsing
> Polish currency has caused a near doubling of borrowers’ monthly
> payments and principals since last year. Austria really has its knickers
> in a twist, as these heavily syndicated loans account for 80% of
> GDP. A 10% default rate could wipe out the entire banking system
> there. Germany has the smallest loan exposure, but has the most to
> lose, with 25% of its exports headed east. It is now in negotiation
> with its partners in the EC to cobble together a bailout with the
> help of the IMF to provide bridge financing for these loans, and
> hopefully ward off a further economic collapse. It looks like the
> headlines in Europe are about to get uncharacteristically sensational.

The Eurozone's Winter of Discontent Approaches Shakespearean Proportions

Seeking Truth: One consequence of curtailing welfare spending will be street demonstrations, and other forms of popular unrest. We are already seeing this phenomenon take shape, in traditional Europe and in the former Soviet satellites. Immigration is another very touchy issue now. Yes, a bit like late-18th century France but more like Europe in the 1920s--another very touch issue, but I guess we must deal with it, sooner rather than later. Many thanks - Rakesh


On Feb 04 01:17 PM SeekingTruth wrote:

> Rakesh, What happens when Welfare states significantly curtail welfare
> spending when the vast number of welfare recipients are already suffering
> more than at any time in memory?
> They have been conditioned for disproportionate assistance and like
> domesticated pets, have little or no ability (or opportunity) to
> fend for themselves.
>
> Are we in the early stages of a certain late 18th century type episode
> experienced by the French, at least in some of the countries?

The Eurozone's Winter of Discontent Approaches Shakespearean Proportions

Yes, numerous people have suggested that Angela Merkel's father (a pastor) must have had close communist links since the family was allowed to travel freely between East/West Germany. Ms. Merkel does not deny that she was a member of the communist-led Free German Youth movement.

On another note, I'm not sure if I agree with your view of the Marxist outlook for Europe. The works of Rosa Luxemburg and her contemporaries [pre-1920s] appear to express strong disagreements with European "socialist" parites with respect to control over the means of production. But this matter is certainly worth investigating further (particularly in today's context) and I will address this in a forthcoming article.

Finally, the failure of the German banks cannot be blamed on the poorer EU states; on the contrary, my view is that the German banks thought they saw a unique opportunity to lend at above-average rates and collect huge fees, and now they are paying the price. Many thanks - Rakesh


On Feb 04 02:29 PM R Jensen wrote:

> How is it that Deutsche Bank and Commerzbank are sinking and yet
> the blame is placed on the poorer EU states?
>
> I'm surprised Merkel was from the DDR. Since she went to school there,
> she must have been a member of the Communist party (otherwise you
> don't go to school, you go work in the factory).
>
> But Merkel is right about the idea of nations going bankrupt. <br/>
>
> I'd say that's more of an "Austrian school" philosophy than a Marxist
> one. After all, Marx would favor EU expansion and a socialist world
> government. And that is exactly what the EU is a building block for.

Financial Company Default Risk

Good summary by Bespoke. But, Crocodilian, you have a valid point, which the regulators must clarify immediately before talking about a central clearing house. How "central" are these CDS contracts? What the variation levels in their contract terms? Many thanks - Rakesh


On Jan 10 07:33 PM Crocodilian wrote:

> Thanks for this. I've been interested in the precise terms of the
> CDS contracts-- and what precisely constitutes a default. We've had
> any number of complex transactions, and these companies often have
> a holding company/operating subsidiary structure.
>
> I've yet to see any discussion about the particulars of WaMu, for
> instance, were the operating subsidiary was purchased by JPM/Chase,
> but the holding company (and its debt) were left outstanding.
>
> In cases like these, or like Bear Stearns, I assume that the CDS
> is not triggered -- but that would depend on the specific language
> of these. In starting to read up on these intruments, there's a remarkable
> opacity and complexity to them, along with room for disagreement
> . . . "credit events" are determined by a "calculation agent", usually
> a third party.
>
> But grounds for disagreement and litigation are many, and there's
> no reason to believe that these instruments will speedily resolve.
> Here's a description of a recent litigation:
>
> "The court first examined whether a credit event had
> occurred. Citibank argued that a particular credit event applicable
> under the contract—an “Implied Write- down”—had occurred because
> the securities held by the Millstone CDO (which had issued the Class
> B notes) had decreased in value. VCG argued that the Implied Writedown
> provision only applied if there was a writedown in the Class B Notes
> themselves, regardless whether there was a decrease in the value
> of the securities in the Millstone CDO. After analyzing the CDS contract
> and the indenture for the Millstone CDO, the court concluded that
> the Implied Writedown provision referred to collateralized assets
> held by the CDO and not to the notes issued by the CDO. Accordingly,
> the court found that Citibank’s determination that a credit event
> had occurred in the form of an Implied Writedown was proper and that
> Citibank was entitled to judgment on the pleadings on that issue."
>
>
> (from "Manhattan Federal Court Enforces ‘Clear’ Terms of Credit Default
> Swap Contract on Pillsburylaw.com website)
>
> The point of all this is that not only are the amounts of outstanding
> CDS contracts huge, but their terms are not necessarily crystal clear
> . . . imagine if you had to litigate to effect settlement of your
> options trades!

Netting Derivatives: Slippery Slope Marred by Opaqueness

Dar rc whalen: Good point re getting rid of traditional ISDA contract formats in favour of insurance-driven documentation. Many thanks- Rakesh


On Jan 07 03:15 PM rc whalen wrote:

> Good comment. The last several graphs are especially important. I
> still do not think people appreciate how entirely screwed up CDS
> contracts are as an insurance/barrier option type offering. In plain
> vanilla, single name CDS, we are pricing the obligation to fund par
> less recovery on a corporate bond default, but we price this risk
> vs. short-term spreads and volatility!!!
>
> Then there is the correlation problem. Unlike ship sinkings and earthquakes,
> traditional low-beta insurance risks uncorrelated to the economy/markets
> (and, indeed, were a hedge to the economy/markets!!!!), CDS is high
> beta and thus cannot really be hedged. Even a very broad portfolio
> of such risks will still go to hell in a severe downturn such as
> we see today. CDS does not manage risk, it creates risk in vast amounts
> in order to generate commission income for the CDS dealer community.
>
>
> That is why I believe that clearing is not really the issue when
> it comes to "fixing" CDS. I think we need to abandon the ISDA model,
> which was copied from the IR/FX template, and look at more traditional
> insurance type models and capital/collateral levels before CDS or
> its successor make sense and thus gain investor support

Netting Derivatives: Slippery Slope Marred by Opaqueness

Dear monday1929: I am in the process of assessing the "even if" scenario you talk about. But, whichever way you look at it, the potential losses are staggering indeed. Many thanks - Rakesh


On Jan 07 02:13 PM monday1929 wrote:

> Even if the liars (banks) were acidentally telling the truth here,
> and assuming all counterpaties will make good (an absurd assumption),
> that may leave about 3 trillion in losses for JPM, Citi ie. the U.S.
> taxpayer.