Tom Jacobs

Writing Naked CDS: When Murder (and Betting on It) Is Legal

There are plenty of agents with no commodity exposure who either agree to deliver or accept delivery of commodities in futures contracts and they perform the role of enabling those with said exposure to hedge and no one wants to take them out to the woodshed. Tangentially, a number of academic studies showed that those tech stocks that could not be shorted due to technical and other factors experienced the largest degree of "bubble" in their shares during the late nineties boom in tech stocks. Thus, I would conclude that the idea that one has to demonstrate an economic exposure to hedge in order to short credit or that shorting both credit and equity is somehow evil is misguided, at best.

I also liked this line from the Barron's piece: "If the total cost of buying a bond and insuring it to par is less than par, it creates an arbitrage that ultimately destroys capital." How does this destroy capital? The arbitrage is to buy the bond and buy protection on the CDS which will drive up the bond price and the cost of insurance until par is reached and the arbitrage is gone.

Tom

Berkshire's Huge Exposure? Nonsense

Recognize the similarities between what Berkshire has done here and what AIG did selling protection on AAA rated CDO tranches. Sell large amounts of "insurance" via derivatives and rely on not having to post collateral to argue the unlikely situation that any payoff will occur or call into question mark to market accounting. Argue it is free money as the author here is doing by showing how unlikely a loss is or how little it costs over time. It is unclear if Berkshire has "paid out nothing" because they are AAA or because their contracts are free of collateral requirements. Fitch downgraded it to AA+ on March 12 so we will soon see.

I still cannot get over the hypocrisy in all of Buffet's "derivatives are weapons of mass destruction" hysteria. He can't have it both ways. If anyone can justify selling these large option positions from a speculative position (there is no hedge here) then how are derivatives such evil contracts?