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Berkshire Hathaway: Proof That the CDS Market Is Irrational

CDS market is unregulated.

Anybody can buy an insurance on anything they do not own. Anybody can buy insurance on any company they do not own at any amount over and above the value of that company. Nobody is going to inquire nor investigate. It is a wild wild west out there.

For example: I can buy CDSs for GE at 10x the value of GE without me owning any stock of GE. Therefore, I will be insuring something I do not own. If GE goes bankcrupt I make a lot of money. Likewise, if I short GE common stock to the hilt in just one day with sufficient capital; it will tank in one day and traders and investors are going to take notice. They will look at the CDS and they will see CDS premium going up (due to my buying spree of CDS) and fear will become the dominant factor. As for me, I can always protect my short positions with stop loss limit and thus will only incur minimal loses.

When fear dominates, logic goes out of the window, investors will be shooting first and asking questions later - they will be selling whatever they can afford to sell to mitigate the unknown or buy as much put options as they can afford. Likewise, traders will be shorting the common stock with gusto knowing very well how to take advantage of investors' fear and panic.

Once the company stock price has gone down drastically, it's tangible book value will deteriorate rapidly and hence the once healthy company becomes insolvent in a very short period of time and will most likely be headed for bankcrupcy. It can happen in a matter of days or weeks.

Question is; how could a viable company suddenly become insolvent in a matter of days or weeks with no radical changes in it's management, it's sales and profit, it's expenses, etc? How could it become insolvent when there was no radical change in the country or the whole world in general?

Do you call this free market forces or can you call this manipulation of free markets?

How could it be that you can insure something you do not own in the first place?

It is like insuring somebody for 1 million dollars and then killing and making additional money robbing that person in order to be able to collect the insurance without breaking any law at all in this wild wild west environment of CDS.

Berkshire Hathaway: Proof That the CDS Market Is Irrational

Too easy then to make money for traders using CDS.

Short the company with high volume daily transactions to the hilt.

Buy CDS of the company with very thin market volume thus needing only small capital to jack up the price.

Presto, everybody saw CDS climbing and the company might be in big trouble. At the rate things do happen these days, you better shoot first and ask questions later. Hence, traders and investors will have to hedge their positons and company shares goes down in a hurry and nobody can stop it even government intervention due to the sheer volume being traded on the company's common.

Goodbye GE, goodby BAC.

Why not use the power of CDS to take Berkshire down? Shorting beaten down stocks do no produce too much profit anyway. Shoot those big fat birds fying high.

I'm no good with CDS thing but that is how I'm starting to understand the positive (or negative) feedback of the CDS market to the equity markets.

Is this Terrorist Scenario possible and how easy would it be to execute such scenairo?

ECONOMIC TERRORIST: Let us destroy those companies that are essential to the US economic survival. A few hundred millions of capital might be enough in order to bring down that giant into it's knees. We will only have to learn how to use CDS to destroy those companies. Once we succeed with one small prey, we will make a lot of money and we can do it over and over again until we can do it with the biggest companies.

Will the unregulated CDS market need to be investigated, regulated, and controlled if necessary in order to prevent such a scenario?

Here I Go, Criticizing Warren Buffett

Why be too pessimistic?

Look, during the 1930s, the industrialized world suffered the great depresion. Stock markets was still young then as far as the western world is concerned. Then the stock market made a 68 years sustained rally from 1932 to year 2000 interrupted only by minor corrections. Minor corrections in context with 1932. Now the stock market is not so young nor it is too old. Dow maybe old but being replenished all the time. SnP is middle age while Nasdaq is definitely young.

Now, the whole world is becomming aware of the stock market. Look at China and India as prime examples. Do you think more than 5% of their population has exposure to their stock markets?
The industrialized world has now more than 50% of population with direct exposure and almost everybody indirectly affected. In the developing countries, stock market is now suffering the same fate as the US during the 1932 crash. Great! Are they going to have the same 68 years of sustained rally? More yes than no. Asians look at crisis as opportunity in disguise much more so than the West. Give them as much as a little chance and they will go for it with gusto.

Likewise, this is only the second time the West have suffered so much stock market upheaval almost nobody of us have seen in a lifetime. Buffett must have seen 1932-1942 depression that is why he remained cash and now is starting to deploy that cash into the equity markets. Another 68 years of sustained rally starting this year or next? Well, he will not live to see it but surely he deserves his last hurray.

Best time to enter is when everybody have already lost hope. Seems like not everybody is desperate yet like me. But are you willing to wait and wait until Dow reaches 5000 or lower; or wait until you have to chase Dow at 12000 or 14000 levels.

In the context of the potential next wave of 68 years rally; this current downturn may be the bottom or next year will be it. It is no wonder Buffett has to act now since he is not known to be good at chasing rallies.

Here I Go, Criticizing Warren Buffett

Investors are scared to death.

Somebody has to start showing the silver linings.

Who can do that better than Buffett?

Buffett and the Limits to 'Awaiting Better Times'

Treasury is now the greatest bubble with every industrialized nation pouring trillions in tresuries and bonds.

I dont know what consequences will be once this bubble burst.

But for sure, those safe cash will start seeking profit generating investments such as manufacturing plants, technology, energy, etc.; rather than in safe hard assets but non-profit generating investments such as housing, gold, diamond, etc.

Buffett and the Limits to 'Awaiting Better Times'

Perhaps the low has not been set yet, but surely the 45% drop so far is a good start to invest since nobody knows if it will ever get to 60%, 70% or even more than 80% lower. Investors call it doubling down and add more on the downturn rather than chase the rallies.

During the gread depression; stock market went down 80% or so for less than 3 year if I am right. However, if you look the yearly chart, Dow Jones made a sustained rally from 1932low to year 2000 high (from $42+ to $14,000+ in 68 years).

Technically speaking, highest probability for Dow is an expanding flat with 4950 target. However, that is only the highest probability. There are lots of possible scenarios that can happen and Dow 8000 or 7000 are good candidates too. You may even say Dow 1000 for extremely bearish scenario.

The point is; the highest probability after this 8+ years of consolidation (check the broader SnP500 on yearly chart with a very clear regular flat pattern either ending with a higher low or a lower low, Dow made higher high for a regular flat or expanded flat if things get worse) is that the US stock market will be in for another 68 years (more or less) of sustained rally.

You dont want to miss that potential 68 years of rally interrupted only by minor shocks in the 70's, 80's and early 90's.

How could this be possible to have another 68 years rally?

Just like in the 1930's. Investment went from business to housing. You know, everybody played safe. If I can see it and touch it (house and lot) it is hard asset. Problem with housing for the most part is that it is an EXPENSE and not a profit-generating investment.

Profit generating investment = BUSINESS enterprises.

The US invested (spent) $1.2T on housing from 2000 to 2007 while investments for business went to China, India and other develoing countries.

The sooner America realizes that house and lot is an expediture and business enterprise is an investment; the sooner they will be able allocate resources into the correct part of the equation.

Businessmen knew that they can buy many other businesses, houses, real state, cars, yatch, private plane, etc. with a successful business enterprise. By the time the business downturn catches up; most excess profits has already been allocated to other safe but less-profit generating investments (treasure, bonds, real estate) and again be re-allocated into risky but more-profit generating business enterprises as the economy recovers.

House and lot prices can go up but they cannot generate cash profit on a monthly or yearly basis. Only the builders, banks and flippers make money in rising house prices. That is, if you stick to house and lot investment - you are stuck.

Buffett and the Limits to 'Awaiting Better Times'

Stockmarket shareholders almost always get the raw deal.

Instead of the govt protecting stockholders, the treasury gave them a kick on the chin with BS, Fredie and Fan, and AIG. No wonder shareholders decided to get out of this anarchic anti-investor environment.

Joe six pack knows nothing of bonds and preferred shares and the mechanics of the stock market while he is being encouraged to invest hard earned cash while saying at the same time no guarantee at all he can make money and may actually lose everything in case of company bankrupcy. Also they dont have the ability to know when to get in and when to get out, thus the ordinary investors got crushed most of the time. Mutual Funds and Hedge Funds are no better than ordinary investors with many of them now on shaky grounds. ETF was another flavor with the same main ingredient which is stocks. Like softdrinks with main ingredient being water.

Banks tried the SIV (Structured Investment Vehicle) with guarantee of capital to investors but no guarantee of profit. Their biggest mistake is that they re-invested those cash in a no-guarantee stockmarkets during the boom days. Now the banks are in big trouble.

Govt has now guaranteeing bank deposits, commercial paper, cash flow to banks, etc. Nothing for the stock market investors. Look here, it is the stock market causing havoc in the first place. Everytime you turned on the TV, it is the stock market destroying the public confidence of the future. Then the inevitable recession/depression follows.

Govt has to protect common shareholders from companies going bankrupt. That is the minimum. To prevent total collapse of the stock market in this extremely volatile environment; govt has to guarantee in part or in full stock share purchases in the next 3 months for 3 years with minimum 1 year holding period.

Mechanisms should be installed to prevent stock prices running 10%, 20% or even 200% in 1 day during the 3 month period. Govt may also charge some insurance fees from those stock purchases to recoup loses from companies going under.

One way to do this is to use a 5% maximum rise/decline capped 20-day moving average as a guarantee price. Any shares bought below will be guaranteed at purchase price and those bought above will be guaranteed at 20-daycma closing price. So if the 20-daycma price is $20 and you buy stock at $22, it will be guaranteed at $20, if you buy at $18, it will be guaranteed at $18. After the price reached the 50-day simple moving average; a 50-day capped moving average kicks in with maximum allowed 3% rise/decline per day with same guarantee mechanics.

Free market will be allowed and daily stock prices can go 10-20-30% in whichever direction. Only that whatever purchases is done by investors - will be guaranteed at or below the government capped 20-daycma and the 50-daycma. After 3 months; the government or private entities may provide insurance policies against company bankrupcies for shareholders willing to insure their holdings. Insurance fees will be very low if not negligible since very few companies go bankrupt with a vibrant economy. Govt can use 50-year bankcrupcy percentage average to estimate how much risk will be taken and how much insurance fee can be charged. No guarantee against stock price fluctuations. Another insurance policy might be conceived for price fluctuations.

This is the very fast and easy way to restore confidence and give a solid ground to the hopes and aspirations of the common shareholders. Good for stock market dummies too. Also, it can be re-implemented during severe stock market crises like today.

Deal with the banks' CDOs, CDSs, and MBAs and the housing mortgage problems in the background. They will take years to unravel. Meanwhile, financial credit crisis is now spreading into commercial credit. This is extremely dangerous to the whole industrial world that depends on commercial credit for the transfer of daily food and necessities among farmers, manufacturers, suppliers and retailers.