Crocodilian

Barclays: Crushed

On Jan 16 03:50 PM User 338847 wrote:

> Are there identifiable 'bad guys' in this drama?

Yes, but more importantly there were identifiably bad _choices_ about how to run the system. Institutional behavior is constrained by what society permits its institutions to do . . . we made some terrible choices in banking.

The repeal of Glass-Steagall -- which had served us very well for 60 years-- and the Commodity Futures Trading modernization acts come to mind as particularly disastrous choices.

But basically, the system needs a disaster every so often to remind everyone that risk is real. When you've gone 70 years from the Depression, and when every market reverse is seen as a buying opportunity, then people won't be cautious enough.

Financial Company Default Risk

@Rakesh
"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"

Short answer: No one knows what the variation in the terms are. These instruments were designed by financial engineers at a small number of institutions -- JP Morgan probably has the best overall picture of what the terms look like.

But the more you read about these instruments, the more complex the story is. These contracts have complex provisions to account for certain kinds of M&A events, for example. The "Calculation Agent" (usually the firm that designed the product) has to evaluate many complex corporate histories, mergers, sales of assets, and figure out how that applies to each of these instruments.

The more you look, the less amenable to "central clearing' the existing instruments appear to be:

European CDS instruments typically have different terms from US ones, for example.

Wikipaedia has an _excellent_ article on CDS
en.wikipedia.org/wiki/...

Financial Company Default Risk

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!

The Lehman Debacle

Gotta disagree with "With hindsight, I still think that a cobbled-together deal between Barclays, Lehman, Treasury, the Fed, the FSA, the Bank of England, and the British Treasury would have been a much better option to what eventually transpired."

The system needed the reality that certain kinds of activities themselves threatened system extinction. By papering over those risks, as occurred at LTCM, the necessary incentive would not have existed.

A "cobbled together deal" is what we've had plenty of: Bear Stearns, Countrywide Financial, the entire Japanese financial system since oh, 1991 . . .

Getting "back to business" must mean taking our losses, and going forward with a healthy fear of sloppy finance. The Lehman failure serves both those purposes.