Gtarras

General Motors and CDS Leeches

"First, CDS may be sold only to those who own underlying debt and who have an "insurable interest"."

I am very curious how the regulators are going to handle all that. The opponents of this idea can make reference to the equity market: i dont have to own stock to write an option, right? so, John's example of house/fire insurance, while very valid, was not a problem with the equities.

But more interestingly is what they are going to do with the structured products. This is where my expertise is, and I have been in the SP market derivatives business since its inception. ALL deals there are customized. You have your ISDA master doc, but then you dance around, tailoring your specific deal to the client needs. These products can not be put on ed yet, they:A) account for major portion of the CDS market (maybe more than half), 2) Are the ones responsible for the current debacle (AIG etc)...


On Jun 02 10:19 PM Alex Trias wrote:

> In the trusts and estates world, "insurable interest" is old hat.
> It is a rule, grounded in state law, that provides a life insurance
> company may not write life insurance on the life of Alex Trias and
> sell such a policy to Tony Soprano. Works well. Alex Trias doesn't
> have to look over his shoulder each day wondering whether Tony Soprano's
> goons are about to shove him off a bridge, and the insurance companies
> don't allow themselves to get ripped off by selling policies to mobsters
> who will simply bump off the the insured. The corollaries between
> life insurance and bankruptcy insurance are manifold, and I think
> Mr. Lounsbury has touched on an absolutely enormous issue.
> I'll suggest two regulatory issues here. First, CDS may be sold only
> to those who own underlying debt and who have an "insurable interest".
> One way to do it. A second way would be to amend bankruptcy laws
> to provide that creditors with CDS coverage on their debt basically
> get booted out of the proceeding and are entitled to no recovery
> in bankruptcy court. This is the de facto approach of the Obama administration
> in connection with the GM bankruptcy, and it will be very interesting
> to observe whether de facto regulatory solutions morph into law over
> time. I think this is, in fact, how new legal regimes are created.
> Thanks to Mr. Lounsbury for raising such a complicated and important
> issue for this community.

General Motors and CDS Leeches

I am sorry John, but your article strikes me as very long on populist hype and short on explanation WHY exactly the CDS market is a giant leech sucking blood out of the host (and whos the host? too much ambiguity).

Why not regulate IR swaps market too then? Its much much bigger, both in volume and as a ratio of swaps (derivatives) to the debt outstanding compared to the credit market.

The reason we would want to restrict CDS issuance would be to avoid situations like AIG (and other monolines) found themselves into, by writing too much of CDS. They underestimated the risk, and found that they could not pay on thier obligations (also, still very questionable if they can NOT, whats certain is they do not meet reserve reqs and need the bail-outs).

So the problem would be solved if they had to post more, which, in a way would limit the amount of exposure they can take. So why not regulate the reserving requirements for the companies instead of the CDS market???

The Most Significant Green Shoot Starts to Wilt

Why not show similar chart only not in absolute numbers, but as a percentage of total work force??? The conclusion could be drastically different. So, in short, great, unbiased piece of research. So cute though when you ask us to find the dip in the blue line.

Buyer Beware: 30 Biggest Bankruptcy Risks

Made couple of spelling errors in previous post. Should read: CDS traders follow tens of companies.

Also, another comment. Technical issues sometimes amplify things. Look at MBI which is on the list. It sells insurance, and thus poses counterparty risk. So many folks who buy insurance from them, are forced to buy protection on MBI (buy CDS), which is fairly illiquid. They still buy it and drive CDS level up. So how much of liquidity premium is built into MBI CDS spread? Trust me, nobody knows.

Buyer Beware: 30 Biggest Bankruptcy Risks

I have spent plenty of time modeling CDS prices and working with CDS traders. While CDS prices do reflect probability of defaults, there are many things that I picked up along the way regarding pricing of these things:

1. Major driver in traders decision to buy/sell CDS is a direction of its price. Not default probability.

2. CDS, unlike bonds, have other covenants that can trigger an event, such as restructuring, moratorium etc.. even downgrade (sometimes).. So CDS reflects more things other than default.

3. CDS prices are driven by equity vol. You dont need to be a genius to know that these guys listed were most volatile. CDS traders usually follow ten of CDSs, do you think they have time to research them. I ALWAYS thought CDS trading was about momentum, not deep research. Also, for many names CDS could be very illiquid. Another thing: CDS levels that traders see on their screens are often not traded levels, but levels suggested by CDS models.

4. If you short equity, you max gain 100%. You buy CDS (similar to shorting a stock) your gain is unlimited. So CDS prices is a great speculative tool on the downside. You dont think hedgies abuse it?

In short, in today's environment, take CDS levels with a huge grain of slat.