Reggie Middleton

On Goldman and CIT: No Free Lunches

"You have "literally" no idea how markets work dude"

Okay, smarty pants. Why don't you educate us on how a CDS is priced on the ABX, and exactly what the tracking error, if any, is on the actual liklihood of an event of default? What is the definition of default on the contracts written on the ABX?

You can also explain to us if there is any discrepancy and/or relationship between the actual credit default (or its probability) and the ability of the trust to pay out to avoid default.

I admit that I am a neophyte in practically all things, so my ears are open.

You say I know nothing of how markets work, but the CDS space is not truly a market, it is a space run purely by an oligarchy of broker/dealers with the Golden formula of pricing/clearing/settl... A true market has price discovery emanating for asks and bids between all members of a community, not gate keepers on Wall Street. Think stock market, housing market, bond market, currency market.

On Goldman and CIT: No Free Lunches

"How do you know the 5 banks with 97% notional aren't individually net flat? "
Let's use CIT as an example. If all 5 banks have CDS positions in CIT, and Goldman has a billion dollar CDS purchase, then in order to net, the other 5 would have to have $1billion on the other side. The problem is that it appears nearly everybody bought CDS on CIT! There are no chatterings about entities that sold more CDS than CIT has debt, now are there? There appears to be significantly more CDS written on CIT than CIT has net debt, or gross debt. This begs the question, "who is on the other side"?

An even more tantamount question is what is the credit quality of those guys who did write the CDS? If they are just a bunch of $100 million hedge funds holding several billion dollars of CDS risk, then there you go. If they are one of these 5 banks who have hegded their risk with the other 4 banks who hedged their risk with the other 3 banks who relied on those first 2 banks to hedge their risk, well then there you go!

I don't know if all 5 bank are net flat, but I doubt so very seriously. I have went through nearly all of their balance sheets, and one (I have released one bank in particular to my subscribers) have written more than a quarter of their TCE in naked CDS, just like AIG did!

If they are all net flat, then has any risk truly been transferred or are they passing the buck around a circle of 5? I can understand a circle of 50,000, but 5???

On Goldman and CIT: No Free Lunches

You comment as if you haven't read the article. The big deal is that CDS are a ponzi scheme ready to collapse. There is no cash market for price discovery, hence the dealers can literally construct pricing due to opacity. There is extreme concentration risk in derivatives in general, and CDS as a subset.

The article is about risk concentration so whether the CDS is a hedge or not, there is still a counterparty on the other side of the transaction. 5 banks hold 97% of the notional value of derivatives. I bet all 5 of those banks have CDS positions on CIT. Thus, exactly how is that risk truly hedged versus simply being shuffled around in a game of counterparty risk musical chairs.

The other big deal (although not nearly as big) is that it is not truly an economic hedge if the payout from the hedge is greater than the payout on the hedged transaction. Economically, it is a speculative position. Don't consider it a game of semantics for it creates an inverse incentive for GS when they benefit more from the collapse of underlying than they do from the repayment of the loan.

On Goldman and CIT: No Free Lunches

YES YES YES! GS has purchased CDS protection on top of the makewhole, at least according to the article. If you have some insider information, I would love to hear it.

"In the case of CIT, market players have bought more insurance than the company’s $30bn in debt. Those holders include Goldman, who purchased such a credit protection to hedge against a June 2008 rescue financing of up to $3bn to CIT, Goldman said. Goldman also held other CIT debt, although the company declined to comment on these other exposures."