CreditTrader

When Hedgies Attack: Morgan Stanley Drops 40% on Rumors

Dear TomArmistead, a) what makes you think Dinallo knows anything about CDS markets, b) what has his comments got to do with my comments on the action today in MS CDS markets and the LACK of directional flow, c) what about short-sellers?, d) what about put buyers? and e) I GUARANTEE you that if and when we regulate CDS trading (which could mean many things from a clearing house to insurance) that the credit crisis will not be over, house prices will not rise, and stocks will still fall.

Moreover, if you understood the nature of CDS markets (NOT CDO, or ABS CDS), then you wouldf realize the need for the CDS to isolate credit risk and allow real money accounts (you know the big pension funds and traditional asset managers NOT hedgies) to actively BUY new issues in the primary bond market with less downside risk. The need to put money to work means that there is a natural demand for IG issuance, and obviously there is a natural supply for refis in IG markets. However, without a functioning CDS market (without the need for insurance-style regulation), these non-fast money accounts would be unable (or unwilling at anything other than uneconomical spreads) to buy new issues. Even with a massive cash-CDS basis currently, counterparty risk is keeping these guys on the sidelines. If we put CDS on an exchange with a central clearing house, I GUARANTEE once again that new issue markets will pick up and the liquidity freeze will thaw in corporate credit.
This is not an issue of 'naked short selling' but more of risk transfer and risk premia - no-one is willing to act coz no-one knows who is infected - if counterparty risk is removed from the picture then liquidity will thaw and as far as i can see, insurance regulators have not exactly been at the top of their game in terms of regulatory control (ABK, MBI, FSA, AIG, HIG)?
Sorry to nag on this one BUT it is really important that people understand the markets that provide a platform for their stock market speculation and how a simple over-regulation can have huge impacts.
Remember - counterparty risk (sometimes called Herstatt risk) is the issue - NOT regulatory control/restriction on protection buyers.

as far as po'd in Plano is concerned, CIT and SLM are in even nore trouble in CDS land, trading considerably wider (riskier) than MS or any of the brokers - you are absolutely right - they are all in the same fund short and lever up boat and CDS simply reflect the reality of their chances of default.

When Hedgies Attack: Morgan Stanley Drops 40% on Rumors

Just for all those conspiracy theorists, CDS markets in MS were pretty much frozen this afternoon. There was no rush to buy protection, there was no massive entrant(s) into the market ahead or after the rumor, there was simply no trading (some indicative levels) but no major trading. Noone is willing to sell protection and thopse that are are not good enough quality to encourage buyers to act...sorry guys, this one is simple, who would want to own a highly leveraged, low quality balance sheet entity whose business model faces significant (understatement) headwinds...and on a day when the CDS market begins to look seriously at a buy-side driven trading and clearing platform. Dealers in general can expect margins to drop significantly (that is why they have been so vociferous over defending the opacity of OTC markets - coz they get the flows and the margins). Sorry to go on - but this whining/blaming CDS for the current situation just shows the level of general ignorance among both retail and professional investors when it comes to financials and credit markets.

Broker Default Risk

The disconnect is simply due to the underlying backstop that the Fed put into the market. This has spread across much of the financials universe where we now see equity levels modestly cheap to where CDS would imply them to be BUT I do also note that implied vol is considerably too low among these names relative to their CDS levels - so a long delta-hedged Put versus CDS protection position should pay out well and also i would expect equity to underperform as the firms are forced to use equity issuance rather than debt/hybrids as Tier 1/leverage ratios come under pressure...love to hear your thoughts...