Are Traders Demanding US Credit Default Swaps Payable in Gold?

[WildspitzE]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

i am most interested in knowing how "default" is defined in these instruments. the definition used might not necessarily be what you or i usually mean by the term. because how can the u.s. default in the usual sense when it can print money to pay debts denominated in dollars?

in general, it is my understanding that the sovereign cds of the u.s, the u.k, and japan are trading sardines, not eating sardines. they are purely for gambling, i.e. trading. the spreads widen, the spreads contract, profits and losses are booked. the u.k. has recently announced they will do some borrowing in other currencies. the cds on THOSE instruments will mean something.

doh! I should have read your post before I posted -- or just say: "yup".

[xPat]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

I'm really disappointed at how many people in the blogosphere are taking this Janet Tavakoli drivel seriously. Tavakoli's specious arguments defy logic or reason. I'm not referring to the part about payment in gold - that makes perfect sense and seems like a logical development. But Tavakoli's attempt to use emotional triggers attached to AIG to make speculators the bad guys and to insinuate that the U.S. Gov't could be their next innocent victim is just plain ludicrous.


AIG got in big trouble because they were a party to CDS contracts. The U.S. Government is not. The analogy Tavakoli draws is therefore specious and misleading. It certainly makes sense to prohibit entities that are beneficiaries of government bailouts from being parties to CDS, and government money should never be used to bail out those who get themselves in deep doo doo as was the case with AIG. But speculators are not the problem; they're just the most convenient scapegoat.


Here's a good interview featuring someone with a functioning brain who points out that CDS contracts can only exist when two parties enter them: http://www.zerohedge.com/article/columbi.... Jim Rogers also explained this in a recent interview when he pointed out that if gold is found in the ground and speculators rush in with investment capital to build gold mines, that doesn't mean the speculators caused the gold to exist. The speculators are reacting to situations not of their own making, and that is the situation with CDS on greek sovereign debt. The speculators didn't run up a 13% deficit against GDP after signing a treaty promising not to exceed 3%. The Greek government did that. All the speculators did was notice the opportunity to profit not at the expense of the Greek Government or the Greek people, but at the expense of the counter-parties selling them CDS and nobody else, by speculating on a default. There is no intelligent reason for anyone to object to this unless one of the parties to the CDS contracts in question is a government or government-subsidized entity. If people must have an emotional reaction and demand that something be banned, then ban Goldman Sachs from teaching governments how to hide their true financial condition from their people and the other countries they sign treaties with.


All of the nonsense flying around in European politics about banning short selling or CDS is very obviously nothing more than political scapegoating, trying to distract attention from the true guilty party (the government that violated its Maastricht treaty decifit cap by more than 420%). They are trying to manipulate the financial naivity of the general public by blaming "speculators" who had absolutely nothing to do with causing the problem. The problem was caused by the very people who are so anxious to put the blame on speculators. This sort of manipulation of public sentiment to assign blame to an innocent scapegoat is not unexpected. But I'm rather disappointed by how many people in the blogosphere who really ought to know better are falling for it. Come on, guys, pay attention!


Banning capitalism because socialists have in recent history been stupid enough to socialize losses of parties they allowed to privatize gains is just plain stupid. I just wish everyone would stop taking the bait from the politicians and understand the issue before they blame speculators or the CDS derivative mechanism for a problem that has nothing to do with them.


xPat

[blazespinnaker]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

You guys are also forgetting the trading / speculating side of the equation. If you take a CDS position now, will such "contract" be perceived to have a higher value in the future? (I know it's all fictitious paper obligations, don't think they don't know this -- the key is to get out right before you actually have to go and make a claim )

Well .. let's be honest with ourselves. I don't think anyone here is forgetting this. We're all aware of this. In fact, I think the itulip community is defined by it's awareness of how screwed up this all is.

What truly is insane about this is how the system just merrily lets this ludicrous activity continue along.

I wonder if it's a massive ploy to become "too big to fail". Buy enough of these CDS and trade it amongst yourselves and the government has to bail them out or risk everything falling apart.

[oddlots]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

Hey xpat,

Did you see the Wolfgang Munchau piece in the Financial Times:

Time to outlaw naked credit default swaps

By Wolfgang Münchau
Published: February 28 2010 20:22 | Last updated: February 28 2010 20:22

I generally do not like to propose bans. But I cannot understand why we are still allowing the trade in credit default swaps without ownership of the underlying securities. Especially in the eurozone, currently subject to a series of speculative attacks, a generalised ban on so-called naked CDSs should be a no-brainer.
Naked CDSs are the instrument of choice for those who take large bets against European governments, most recently in Greece. Ben Bernanke, the chairman of the Federal Reserve, said last week that the Fed was investigating “a number of questions relating to Goldman Sachs and other companies in their derivatives arrangements with Greece”. Using CDSs to destabilise a government was “counter-productive”, he said. Unfortunately, it is legal.
CDSs are over-the-counter contracts negotiated by two parties. They offer the buyer insurance on a bundle of underlying securities. A typical bundle would be €10m worth of Greek government bonds. To insure against default, the buyer of a CDS pays the seller a premium, whose value is denoted in basis points. Last Thursday, a CDS contract on five-year Greek bonds was quoted at 394 basis points. This means that it costs the buyer €394,000 per year, for five years, to insure against default. If Greece defaults, the buyer gets €10m, or some equivalent. What constitutes default is subject to a complicated legal definition.
A naked CDS purchase means that you take out insurance on bonds without actually owning them. It is a purely speculative gamble. There is not one social or economic benefit. Even hardened speculators agree on this point. Especially because naked CDSs constitute a large part of all CDS transactions, the case for banning them is about as a strong as that for banning bank robberies.
Economically, CDSs are insurance for the simple reason that they insure the buyer against the default of an underlying security. A universally accepted aspect of insurance regulation is that you can only insure what you actually own. Insurance is not meant as a gamble, but an instrument to allow the buyer to reduce incalculable risks. Not even the most libertarian extremist would accept that you could take out insurance on your neighbour’s house or the life of your boss.
Technically, CDS are not classified as insurance but as swaps, because they involve an exchange of cash flows. The CDS lobby makes much of those technical characteristics in its defence of the status quo. But this is misleading. Even a traditional insurance contract can be viewed as a swap, as it involves an exchange of cash flows. But nobody in their right mind would use the swap-like characteristics of an insurance contract as an excuse not to regulate the insurance industry. The fact that, unlike insurance, CDSs are tradeable contracts does not change the fundamental economic rationale.
The whole idea of modern financial products is to replicate the payment streams of other, more traditional instruments, while offering better conditions. Selling a CDS is like buying a bond. Buying a CDS is a way of shorting a bond – or of insuring against its default. But that does not change the fact that once you strip away the complex technical machinery, you end up with a product that offers insurance – even though it is a lot more versatile than a standard insurance contract.
Another argument I have heard from a lobbyist is that naked CDSs allow investors to hedge more effectively. This is like saying that a bank robbery brings benefits to the robber. A further stated objection to a ban is that it would be difficult to police. There is no question that a ban of a complex product, such as a CDS, involves technical complexities that commentators like myself probably underestimate. It is conceivable, for example, that the industry might quickly find a legal way round such a ban. Then again, we would not consider legalising bank robberies on the grounds that it is difficult to catch the robber.
So why are we so cautious? From conversations with regulators and law-makers, I suspect they are not always familiar with those products, to put it kindly, and that they may be afraid of regulating something they do not understand. They understand, or think they do, what a hedge fund is. Restricting hedge funds is something they can sell to their electorates. Hedge funds were not at the centre of the crisis, but they are a politically expedient target. Banning products with ugly acronyms that nobody understands seems like unnecessarily hard work.
I do not want to exaggerate the case for a ban. This speculation is neither the underlying cause of the global financial crisis, nor of the eurozone’s underlying economic tensions. But naked CDSs have played an important and direct role in destabilising the financial system. They still do. And banks, whose shareholders and employees have benefited from public rescue programmes, are now using CDSs to speculate against governments.
Where is the political response? The Germans want to bring it to the Group of 20, but they hesitate to do anything unilaterally. Christine Lagarde, the French finance minister, was recently quoted as saying: “What we are going to take away from this crisis is certainly a second look at the validity, solidity of sovereign [credit default swaps].”
A second look? I wonder what they saw when they looked the first time."


I see looting. I see gambling with no economic benefit and enormous economic costs. I see rent seeking. I see nihlism.


And behold, I see a backlash:


http://jessescrossroadscafe.blogspot...-excluded.html



What do you see?

[jiimbergin]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

I'm really disappointed at how many people in the blogosphere are taking this Janet Tavakoli drivel seriously. Tavakoli's specious arguments defy logic or reason. I'm not referring to the part about payment in gold - that makes perfect sense and seems like a logical development. But Tavakoli's attempt to use emotional triggers attached to AIG to make speculators the bad guys and to insinuate that the U.S. Gov't could be their next innocent victim is just plain ludicrous.


AIG got in big trouble because they were a party to CDS contracts. The U.S. Government is not. The analogy Tavakoli draws is therefore specious and misleading. It certainly makes sense to prohibit entities that are beneficiaries of government bailouts from being parties to CDS, and government money should never be used to bail out those who get themselves in deep doo doo as was the case with AIG. But speculators are not the problem; they're just the most convenient scapegoat.


Here's a good interview featuring someone with a functioning brain who points out that CDS contracts can only exist when two parties enter them: http://www.zerohedge.com/article/columbi.... Jim Rogers also explained this in a recent interview when he pointed out that if gold is found in the ground and speculators rush in with investment capital to build gold mines, that doesn't mean the speculators caused the gold to exist. The speculators are reacting to situations not of their own making, and that is the situation with CDS on greek sovereign debt. The speculators didn't run up a 13% deficit against GDP after signing a treaty promising not to exceed 3%. The Greek government did that. All the speculators did was notice the opportunity to profit not at the expense of the Greek Government or the Greek people, but at the expense of the counter-parties selling them CDS and nobody else, by speculating on a default. There is no intelligent reason for anyone to object to this unless one of the parties to the CDS contracts in question is a government or government-subsidized entity. If people must have an emotional reaction and demand that something be banned, then ban Goldman Sachs from teaching governments how to hide their true financial condition from their people and the other countries they sign treaties with.


All of the nonsense flying around in European politics about banning short selling or CDS is very obviously nothing more than political scapegoating, trying to distract attention from the true guilty party (the government that violated its Maastricht treaty decifit cap by more than 420%). They are trying to manipulate the financial naivity of the general public by blaming "speculators" who had absolutely nothing to do with causing the problem. The problem was caused by the very people who are so anxious to put the blame on speculators. This sort of manipulation of public sentiment to assign blame to an innocent scapegoat is not unexpected. But I'm rather disappointed by how many people in the blogosphere who really ought to know better are falling for it. Come on, guys, pay attention!


Banning capitalism because socialists have in recent history been stupid enough to socialize losses of parties they allowed to privatize gains is just plain stupid. I just wish everyone would stop taking the bait from the politicians and understand the issue before they blame speculators or the CDS derivative mechanism for a problem that has nothing to do with them.


xPat

thanks for your excellent post.
jim

[xPat]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

Of course it makes sense. It's like buying insurance

What doesn't make sense here is the definition of a "default", it's the sovereign that prints the reserve currency for the world.

and

i am most interested in knowing how "default" is defined in these instruments. the definition used might not necessarily be what you or i usually mean by the term. because how can the u.s. default in the usual sense when it can print money to pay debts denominated in dollars?

The answers are not completely obvious nor are they consistent due to the fact that these contracts are non-standardized OTC instruments. In other words, the contract could say anything and each one [has the potential to be] different.

CDS pay when a "Credit Event" occurs, and they vary in terms of what constitutes a credit event. It could be a technical default as the name CDS would seem to imply, but it can also mean a downgrading by a specified rating agency.

The notion of a technical default by the U.S. on treasury debt seems pretty absurd to me. Since U.S. treasuries are denominated in U.S. controlled USD and the government has the ability to monetize at will, the only plausible scenario where a technical default could occur would be a strategic default. In other words, they don't have to default but they choose to. One reason to do that would be a strategic selective default, which several gurus have suggested could be in the future. First, you pick someone to blame for all the US' self-created problems, then you "get even" with them by defaulting on bonds held by your bad guy of choice. Or default on all bonds held by foreigners.

But those are pretty far-fetched scenarios, and the far more likely U.S. "default scenario" is what some have called default by inflation, meaning there is no technical default, but the money gets paid back (in notional terms) using watered down dollars after an intentional devaluation of the currency. The amazing thing about the recent fad of writing CDS against U.S. treasuries is that it's shocking how many people who should understand this don't. I can't prove this (because CDS contracts are OTC and not fully standardized), but I am convinced that a whole lot of institutional suckers have been sold CDS "protecting" them against default risk on U.S. Treasuries. Of course the people holding 30-yr treasuries are never going to get paid back in real terms - but the virtual default will very likely come in the form of a notional payback after a devaluation. In other words, CDS won't help you in this situation unless the CDS contract is somehow triggered by a default in real terms or an agency downgrade.

A source of great curiosity for me is all the talk about Moody's threatening to downgrade treasury ratings. As I understand it, rating agencies mission is to gauge risk of an actual default. Since the debtor can monetize at will, the notion of a technical default seems infinitesimally small. Yeah sure, it's regular and normal to downgrade sovereign debt when deficits get out of control, but the reason for that is that those out of control deficits increase risk of an actual default when the country in question doesn't have the ability to monetize at will, which the U.S. does. I can't figure out what Moody's is smoking if they really think there is a serious risk of a treasury default in nominal terms. I consider the risk of default in real terms to be a certainty, but unless I'm mistaken that's not what ratings agencies are chartered to assess.

xPat

[blazespinnaker]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

I've always wondered what would happen if the Federal Reserve decided to start forgiving US debt.

[ThePythonicCow]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

There is no intelligent reason for anyone to object to this unless one of the parties to the CDS contracts in question is a government or government-subsidized entity.

Swaps between consenting adults are ok, huh?

I doubt that.

Even swaps between parties that are not government subsidized can have destructive impact on others. Everyone has arrangements with others. If you incur self-inflicted harm or if you inflict harm on a consenting partner, then you indirectly harm the others who had been counting on you or that partner somehow.

I'm not saying that all swaps are bad. But I am saying that irresponsible swaps are bad. We each have a moral responsibility to those about us to act in ways that further healthy arrangements and avoid harmful ones.

This moral dictate is not limited to "government subsidized" arrangements.

[ThePythonicCow]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

The notion of a technical default by the U.S. on treasury debt seems pretty absurd to me. Since U.S. treasuries are denominated in U.S. controlled USD and the government has the ability to monetize at will, the only plausible scenario where a technical default could occur would be a strategic default.

I can imagine one other scenario that leads to default.

First restate U.S. Treasuries from U.S. controlled Dollars to some "world meta currency." Then default the old fashioned way, like other debtors do, announcing that you will be paying out less, or later or on otherwise less favorable terms.

Of course, to get to that scenario, we first have to write a couple of "doomer porn" chapters in the "History of United States Finances" book, which given the dominance in the world of the U.S., likely corresponds to some related chapters in the "History of Human Finances" book.

Oh goodie -- I love doomer porn !

[xPat]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

Hey xpat,

Did you see the Wolfgang Munchau piece in the Financial Times:



What do you see?

I see another example of a guy who correctly intuits that something is broken, but who gets it wrong when he tries to analyze what is broken.

I agree with some parts of what this guy says - it's true that markets have been destabilized and that CDS was at the heart of the story. But the business about "being used to destabilize governments" is nonsense. The factor destabilizing Greece is the fact that its leadership ganged up with Goldman Sachs to perpetrate fraud against its citizens and other members of the EU.

The problem with CDS is not that there is something intrinsically wrong with the mechanism of a default swap. It's really just a different flavor of a put option when you think about it. But the fact that investment banks and insurers have gotten away with hiding their true risk exposures from their shareholders and regulators (what happened with AIG) is destabilizing to markets and needs to be stopped.

But it seems that the distinction between speculators using mechnisms like CDS to make entirely valid and appropriate speculative bets cannot be discerned in the mind of the average journalist from the shameful accounting games that i-banks and other parties have engaged in to hide their true risk exposures. It's really not that complicated, and I think it a pity that they can't seem to see it clearly and report on it clearly.

xPat

[cjppjc]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

I've always wondered what would happen if the Federal Reserve decided to start forgiving US debt.

I have suggested that as a possible solution to the national debt before. It makes sense.

As for a CDS paying off in the event of a downgrade, that could lead to a nice bribe.

[thriftyandboringinohio]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

For those interested, here is the JPM Handbook on CDS.
Save copy of the PDF, get a six-pack, and read it.

http://www.zerohedge.com/sites/defau...erivatives.pdf

[Adeptus]

Re: Are Traders Demanding US Credit Default Swaps Payable in Gold?

The only thing more concerning than paying back in gold, would be to pay back in land....You know, in the event all that Fort Knox gold is filled with tungsten.

How many trillions is all the US land worth again? Imagine a default large enough that would result in a state or two being handed over to a single counterparty, one can start their own country that way! I wonder what they would call it?Goldmanland? Or maybe Chimerica?

Adeptus