Good Math, Bad Math

So, the financial questions keep coming. I’m avoiding a lot of them, because
(A) they bore me, and (B) I’m really not the right person to ask. I try to stay
out of this stuff unless I have some clue of what I’m talking about. Rest assured, I’m not spending all of my blogging time on this; I’ve got a post on cryptographic modes of operation in progress, which I hope to have time to finish after work this evening.

But there’s one question that keeps coming in, involving the nature of things
like so-called “Credit Default Swaps”, which I thought I’d explained, but
apparently my explanation wasn’t particularly clear. So I thought I should fill
in that gap, and strengthen the main weakness in my earlier explanations.

The basic question is: “What’s a credit default swap?”; I think what people
really want to know is both what, specifically, a credit default swap is, and how
the system surrounding credit default swaps and related monstrosities work.

Credit default swaps are interesting – in the same way that a Rube Goldberg
device is interesting. They are in a fundamental sense very simple, but the
structure that’s built up around them is so bizarre, so ridiculous on the face of
it, that when you look at it in retrospect, it’s hard to believe that anyone
actually thought that it was a good idea, or that it could ever work.

A credit default swap is something in between a gambling chit and
an insurance policy. To understand that, it’s easiest to start by looking
at how these things come about. (The numbers in the explanation are made up, but they’re not unreasonably far afield from reality.)

Suppose that I’m running the BigNosedGeek pension fund. It’s incredibly
important that I keep the money in the fund safe. At the same time, it’s important
that I invest the money intelligently, so that the money in the fund grows over
time, to ensure that I’ll be able to pay the benefits that I’ve promised to all
the big-nosed geeks. I’ve got two opposing goals: I want to be safe, and the
safest investments tend to earn very little money; I want to make a decent return
on the money, but the investments with good returns tend to involve some risk. In
fact, that’s deliberate: the reason that risky investments pay more is that they
need to justify their risk – to provide something to the investor to entice them
to buy the riskier investment instead of the safe one. In effect, you pay for
safety.

Now, suppose that this year, BNG pension has a billion dollars to invest. I
can invest it in federal government bonds for a return of 2%/year. That’s a pretty
lousy return for a billion dollar investment. Instead, I decide that I want to
invest in mortgages, which will earn me 8%. That’s much better. And
historically, that’s a a very safe thing! Of course, while it’s reasonably safe,
it’s not guaranteed to be safe. So I want to protect my investment. I
want to buy insurance to cover my investment – so that if it goes bad, I
won’t lose any of the money that’s supposed to cover retired BNGs.

How can I insure a billion dollar investment in mortgages?

This is where the credit default swaps come in. In a CDS, you pay someone to
take on the risk of the investment failing. You’re swapping the risk of credit
default with someone, in exchange for a payment. What you basically do is go to a
financial market, and say “I’ll pay someone 2% per year if they’ll cover my $1
billion investment in mortgages.” If someone takes you up on that, you pay them
$20 million per year – and in exchange, they promise to replace your money if the
investment goes sour.

Everyone’s happy. You’ve invested your $1 billion in mortgages, which will
earn a nice healthy return. Even after paying someone to take on the risk, you’ve
doubled the return on your investment. The guy who took you up on your offer is
making $20 million per year, for doing nothing, so long as the mortgages
are good. He’s taking on a risk – he’s going to be on the hook for a lot
of money if something goes wrong. But he’s getting a lot of money for a minimal
risk. He doesn’t even need to have the $1 billion on hand; he’s just promised to
pay it if something goes wrong. He’s got no money tied up in it – he’s
just being paid! Everything is wonderful.

That’s the idea of the credit default swap. Sell the risk of an investment to someone else.

In gambling terms, you can look at the CDS as a bet that the a loan is going
to default. You want to be covered in case the loan defaults; so to
protect yourself, you make a high-odds bet against your investment.
Then if the investment goes bad, the bet pays off.

A bookie wants to make money no matter what happens. If he’s taking
bets on a boxing match, then he’ll offer odds to different betters in
a way that producing a balance. Suppose you’re looking at a fight between
Freddie the Fighter and Charlie the Challenger. How does a bookie set the odds
of the fight of Charlie verses Freddie? He looks at who’s betting which way,
and sets up the odds so that no matter who wins, he’ll have enough money to
pay the people who bet on the winner, with some left over for himself. If
the fighters are very evenly matched, and the bets are running even, then
he’ll give equal odds: bet 1 dollar for charlie, and if you win, you’ll get
back an extra dollar. If Charlie is really a hobo who Freddie’s promoter hired
to take a fall to extend Freddie’s undefeated record, then the odds are
going to run very heavily against Charlie: betting for Freddie to beat Charlie
could only pay off $0.001 for each dollar bet, whereas betting $1 for Charlie
would win $1000 if he won. The bookie is going to manage the odds that he’s
giving betters to mantain the balance.

Credit default swaps are a form of bet, and they’re working inside of a
market, which acts as a sort of headless bookie. The market effectively sets the
odds in a way that strikes a balance. A credit default swap is, basically, a bet
that a particular loan will default. So if I’m bank A, and I’m loaning a billion
dollars to bank B, I want to be sure that I’ll get my money back. One way of doing
that is, basically, to place a bet. I bet that bank B is going to default on the
loan. Since B is very unlikely to default, the odds on that bet are huge – I can
bet one million dollars that they’ll default, and if they do, the bet will pay off
all $1 billion.

The problem with this is that no one is going to take the other down side of
the bet. On one side, you’ve got someone who wants insurance against an exceeding
unlikely event – so they’re willing to put up some money, effectively betting on a
very unlikely outcome, but with huge payoff odds – things like better $1 million
that a bank will default, expecting to lose the million, but with the proviso that
if the bank defaults, they’ll get a $1000 to 1 payoff. But on the other
side, you’re talking about putting $1 billion to win a paltry $1 million. That
makes no sense at all – no one’s going to put up a billion dollars for a return of
one tenth of one percent! To try to get around this, the people who set up the
market sweeten the deal in two ways.

First, if you take the bet against the bank, the money that gets bet is yours.
So if the other guy bets $1 million that the bank will default, you get a million
dollars up front.

Second, if you take the bet against the bank, you don’t have to put up the
money up front
. By taking the money bet by the other guy, you’re making a
commitment to pay up if the unlikely event occurs, but you don’t need to pay up
front. So, you get to take the money bet by the other guy, and you don’t need to
tie up your own money. Odds are, that’s a damned good deal. You’re getting money
for doing nothing.

Looked at in gambling terms, the CDS looks pretty much like a scenario where
you go to the bookie, and say “I want to bet on the champ defeating the hobo”; and
the bookie just gives you the money bet on the hobo winning, and takes
himself out of the picture. If the hobo does win, you’re holding the bag to to pay
off everyone who bet on the hobo at huge odds. The bookie didn’t make sure that
you had enough money to pay off the bets if the hobo won. The bookie doesn’t
really care; he’s not losing anything. If the bettor can’t come up with the money,
it’s the other bettors who won’t get paid. The bookie is just an agent
for connecting up the betters on the two sides; the question of who’s going to be stuck paying the betters isn’t his problem.

Just going this far, it should be obvious what can go wrong. What if the
investment goes bad, and the guy who took your swaps can’t pay up? There’s no real
guarantee here: just an agreement. The guy who took the swaps doesn’t have to
prove that he’s got some plausible way to come up with the money! The swaps
market is private, with no regulation. People in the market trust each other
because it’s profitable (in the short run) to trust each other. But there are no guarantees. All it takes to buy up a collection of CDSs is enough money
to buy into the market. Not necessarily enough money to pay off the CDSs you buy – no one checks that. All you need is the money to buy a position
in the market.

But as is all too common in situations like these, it gets a lot worse.

What if you believe that the mortgages are going to go bad, and you want to
make money on it?

Just like there’s no guarantee that the guy who accepts the credit default
swap will be able to pay up, there’s no guarantee that the person
offering the swap actually has the investment that it covers! I don’t
have to have $1 billion worth of mortgages to make a deal to buy $1 billion of
credit default swaps. The swaps are completely decoupled from the instruments that
they purportedly were created to ensure.

So you wind up with things really degenerating down to the gambling scenario. The CDS isn’t just an insurance policy to protect an investment. That might have been the intention when it was invented, but that’s no longer true. Now it’s
a true bet: anyone who thinks that a loan might default can place a bet on it
happening. Anyone who thinks that a loan won’t default can place a bet on it. And this gambling system goes beyond just loan defaults. There’s a whole system of
contracts which started as pseudo-insurance, and turned into gambles – for example, if you’re worried about the US dollar decreasing in value, there are
derivatives which are similar to CDSs which are tied to changes in the exchange rate of the dollar relative to other currencies. So you’ve got a very complex
system which is really a gigantic, unregulated, unverified gambling arena.

To make matters worse, bets in the CDS market are treated as assets. That is,
if you’ve got a chit showing that you took a CDS that paid $1 million/year, that’s
treated as a real asset worth $1 million. So you can use the bet as collateral for
loans outside of the CDS market – and then those loans are guaranteed by
other CDSs, which then become assets, which can be used…

And of course, no one could have predicted that that would be a disaster,
right?

The other question that people keep sending me relates to the fact that I’ve made it clear that I’m in favor of regulation. The question is “How could regulation have prevented any of this without totally gumming up the market?”

To some extent, you can’t. But that’s not necessarily a bad thing. One way of
looking at the current chaos is that there’s a huge amount of stuff in the market
that’s built on sand. There’s a whole lot of fake wealth – stuff that’s created by
piling up levels of “wealth” that are based on absolutely nothing at the bottom.
Being paid for a CDS which is based on a loan collateralized with another CDS,
which is based on a loan collateralized by another CDS – that’s not really creating wealth. That’s just creating an illusion of wealth, which can be used as a tool for tricking people into thinking that you’ve got something
really valuable. If the CDS market were regulated, and you couldn’t take
on a swap without demonstrating that you had a genuine ability to pay it off
if it went bad, then a lot of the speculative stuff that drove a huge amount
of economic activity would never have occurred. I would argue that
it was fraudulent economic activity, and that the fraud that drove the markets
in things like CDS shouldn’t have been permitted. If you exclude that kind
of massive fraud, then a lot of economic activity goes away – and with it,
you would see a reduction in money available for borrowing (both by individuals and by businesses), you would see a reduction in business revenue growth, and a reduction in government revenues. But in the long run, the fact that worthless
stuff is worthless is going to come back to haunt you – if you tolerate
the fraud, then you’ll see nice apparent growth for some period of time, but
eventually, it’s going to crash and burn.

Comments

  1. #1 wikinite
    October 23, 2008

    So, is it considered fraud, and if not, why not?

  2. #2 Soren
    October 23, 2008

    As Mark describes it cannot be fraud.

    The players all abide by the terms of the contracts they make with each other.

    Part A buys the insurance and Part B promises to pay up if the loans defaults. If the contract doesn’t specify that part B must have the means available to pay up, there is no fraud there.

    You are free to make any type of contract, as long as it doesn’t break any laws. (IANAL as should be obvious)

  3. #3 Roman Werpachowski
    October 23, 2008

    Just a couple of comments from a guy working in this area of finance.

    In general, I agree that the credit derivatives market could use some regulation. For example, an exchange for CDS contracts is a good idea and will probably happen some time in the future. Market participants are now very concerned about counterparty risk, and having some rules set in place would alleviate these risks (suppose I bought protection on company X from Merril Lynch — how much should I trust Merril to pay me my money when X defaults?).

    “That is, if you’ve got a chit showing that you took a CDS that paid $1 million/year, that’s treated as a real asset worth $1 million. ”

    That’s not true. Without going into details how CDS contracts are valued, you take the expected value of all future cash flows (both coupons you receive and contingent payments you might have to do) and discount them using a yield curve. So even if your CDS paid $1 million/year, but the probability of the underlying company defaulting has risen, your CDS is not worth $1 million. In fact, it can have a negative value.

    BTW, this has (for a bank) an unpleasant effect that owning a large pool high-risk CDS can cost you money even before you have a credit event (it’s a more general thing that just a default, for example we had a credit event on Fannie and Freddie, even though they didn’t default), just because the amount of “regulatory capital” you possess decreases. Regulation is a double-edged sword ;-)

    “If the CDS market were regulated, and you couldn’t take on a swap without demonstrating that you had a genuine ability to pay it off if it went bad”

    This could be done in the same way as in the futures markets, that is by margin requirements. If the mark-to-market value of your position in CDS market drops below a certain value, you either unwind the position or post collateral.

    The problem is, in such a catastrophical market as we have now, ordinary tactics don’t work, because:
    1. the defaults are highly correlated, so diversification doesn’t work
    2. market is so risk-averse, that a mortage-backed security can be impossible to be sold (i.e. you won’t unwind your position), even though it is absurd to assume that 100% of underlying mortgages won’t be paid back).
    3. to mark-to-market your position, you need to have a model telling you how to value your security. Our models are, to put it bluntly, crap. For example, nobody knows how to model the recovery of the defaulting firm’s obligations properly.
    We can’t fix 1. or 2., but we should have tried earlier (that means you, Mr Greenspan!) not to allow for such a situation to happen. Like, Fed shouldn’t have had negative real interest rates in 2002. The mortgage bubble should have been burst earlier. As for 3., I am trying to come up with some better models myself ;-)

    There are two problems in the credit derivatives market:
    1. moral hazard: I can buy protection on company A and then do stuff to it to make it more likely to default. Even if I don’t succeed in bringing it to default, I can make the market think that A is more likely to default and realize a riskless profit from the increase in the protection cost for A.
    2. information assymetry: a bank gives a loan to a company and then buys a CDS to protect itself from this company’s default. Who knows better the company’s creditworthiness: the bank or the protection seller? The answer is obvious.

    And now the killer part: there is a rumour that Lehman Brothers sold protection on itself ;-)

  4. #4 John Miller
    October 23, 2008

    @Wikinite:

    Yes and no. Fraud implies that one side of an agreement induced the other to enter into it with false, insufficient, or misleading information. Everyone in the CDS market knew what the rules of the game were when they signed the contracts. Therefore CDS in and of themselves are not fraudlent.

    On the other hand, using CDS’s to hide or create unstable market positions, then representing that position as sound in order to secure credit or investment would be fraud. The legal challenge will be to show that someone intended to hide or create and unstable position with these investments, and convincing 12 Americans with 10 months of free time on their hand to sit on a jury of that fact beyond a reasonable doubt. We are after all talking about people who got their legal ad financial training from watching Judge Judy.

  5. #5 Roman Werpachowski
    October 23, 2008

    PS. The market *is* somewhat regulated now. Look up ISDA Master Agreement, etc. Without some standardization of the CDS contracts, there would be huge legal risks.

  6. #6 Beowulff
    October 23, 2008

    Wikinite, as the article explains, it’s not regulated at all, so almost by definition, it is not illegal. Now, whether it’s ethical is a completely different matter. Or whether it should be made illegal.

  7. #7 Beowulff
    October 23, 2008

    OK, I mostly answered because it looked nobody was replying yet. Listen to the people who clearly know more about this than I do :)

  8. #8 John Armstrong
    October 23, 2008

    As I understand it, there’s another side that makes everything that much worse: lack of regulation makes this all private.

    Say funds A and B arrange a CDS, where B takes a certain amount of risk for A. This is all done in private between the two funds, and so when fund C talks to fund B about another deal he has no way of knowing that B is on the hook to A for a certain amount already. That makes it very difficult for C to determine just how trustworthy B really is, and whether B is really good for what he promises to pay C.

    Now this doesn’t raise anybody’s suspicions for a while, because nothing goes wrong. Nobody is called upon to actually pay up on any of these longshot bets. But suddenly some of the bets throw up their flags and people have to pay off… and they don’t have the money to do so. So they call in their chits and find out that they people who owe them money don’t have it either! And so even if the system survives that first blow of the chickens coming home to roost, nobody wants to trust anybody anymore because they’re suddenly very aware of how little they know about their neighbors.

    This is what the decision that CDSes don’t have to be monitored like securities has bought us.

  9. #9 rvs
    October 23, 2008

    I’m with Roman on transparent posting of margin (e.g. exchange trading) as the best mechansim for eliminating counter-party risk (which is really the risk that this post is focusing on and which has indeed been the source of the problem).

    The main point I’d make about your post, Mark, is that all of the problems you associate with CDS in particular apply more generally to all OTC forward payment contracts (not having the security you’ve promised to deliver, no regulation, poor collateralization, et al). In fact, they exist in even bigger quanities in other OTC markets. In particular FX and interest rate swaps make CDS look like nothing. Yet FX has been operating this way for a couple of hundred years and has never blown up completely. Seems to me an informed analysis would look at what has changed in the OTC market itself in recent years and use that to discuss the problem. (Incidentally, I sat in a meeting on this week where it was clear that the problems made manifest by CDS are causing people to take another look at FX for similar problems).

    So criticisms of CDS need to be expanded to talk about the whole OTC market and not just CDS. A more enlightened analysis of CDS in particular would point out that CDS are a natural outgrowth of bond market illiquidity and in fact make a significant contribution to bond investors being able to move in and out of positions more easily. Something which, if you’ve ever looked closely at the bond market, can only be regarded as a good thing.

    The instrument itself is not the problem, the problem is a general one for the market in which it is traded. Market participants have become able to game the system through information asymmetry and the rupture in trading which has occurred in the past month is a natural response to the asymmetry.

    And the market participants are going to fix it through daily marks, margin requirements and neutral 3rd parties knowing everyone’s positions, i.e. moving what is now high bid/ask spread OTC trading onto tight spread exchanges.

  10. #10 Blake Stacey
    October 23, 2008

    You’ve got a chunk of text being parsed as LaTeX, in the paragraph beginning “This is where credit default swaps come in”. Looks like you have the replacemath2.js script referenced in your Individual Archive Template.

  11. #11 hexatron
    October 23, 2008

    It’s been covered:

    Bialystok: How much of “Springtime” have we sold?
    Bloom: Twenty-six thousand five hundred per cent.
    Bialystok: And how much do we have?
    Bloom: There’s only one hundred per cent of anything, Max.

  12. #12 Roman Werpachowski
    October 23, 2008

    CDS market created a very efficient mechanism of estimating default risk. So efficient, that people are valuing bonds from CDS spreads. It would be bad to destroy this thing.

    Please also note that it’s not as if the CDS market stopped functioning now. What is dead are ABS and ABCDOs, but they are not the whole credit derivatives market. Credit indices are actively traded, including the index tranches which were not traded previously (60%-100%, for example).

    See also: http://www.defaultrisk.com/pp_other171.htm

  13. #13 Kevin
    October 23, 2008

    Mark or Roman or someone…

    There is something fundamental I don’t understand here. In you simplistic storyline, you are paying for safety when you buy treasuries instead of mortgages.

    But treasuries were at 2%, and mortgages-minus-CDS at 8%-2%=6%. And both supposedly with similar risk. Roman says the CDS is an efficient mechanism for pricing risk. But I don’t get it. Seems like either treasuries *should* have been at 6% all along to match motgage-CDS. Or that the CDS should have been 6% so that motgage-minus-CDS would match treasuries.

  14. #14 rvs
    October 24, 2008

    @kevin

    you are correct – the example elides over a key point. Mortgages-Treasuries are called the spread (in particular the MBS spread) and it will closely, but not exactly, match the CDS spreads. The not exact part is, for technical reasons having to do with investor preference, contract differences and counterparty risk, negligible in examples like this. i.e. the example should have the CDS spread = the Mortgage spread otherwise you have an arbitrage opportunity.

  15. #15 rvs
    October 24, 2008

    @roman at October 23, 2008 6:55 PM

    dunno about the indices being all that active. ABX looks pretty dead to me these days. :)

    And frankly, on-the-run series iTraxx and CDX tranches are pretty illiquid too. The main indices look good, but guys I’m familiar with are staying in the series 9 iTraxx tranches and not rolling because there’s not enough liquidity.

  16. #16 Roman Werpachowski
    October 24, 2008

    @kevin

    Treasuries can have lower yields because (AFAIK) the income from treasuries is taxed differently. Also, there is a thing called “liquidity premium” — T-bills are very liquid, so investors can exit their positions easily, so they demand lower yields.

    For this reason, the “risk-free rate” in credit market is taken to be LIBOR (the rate banks lend to each other), not treasury rate. And LIBOR was often much higher than treasury. But it’s all fuzzy at the moment.

    @rvs

    I should have said “credit indices which are not based on mortgages”.

    “guys I’m familiar with are staying in the series 9 iTraxx tranches and not rolling because there’s not enough liquidity.”

    Really? I will check it, sound surprising to me.

    Disclaimer: all I have written here is my private opinion, in any way does it constitute the opinion of my employer.

  17. #17 Dunc
    October 24, 2008

    that when you look at it in retrospect, it’s hard to believe that anyone actually thought that it was a good idea, or that it could ever work.

    They were a great idea, and they totally did work – a whole bunch of people made themselves rich beyond dreams of avarice. What other definition of “working” could there be?

    Markets don’t serve some abstract societal “good”. The sooner we all learn this the better. Markets (in the modern, abstract sense) are simply a means for very clever and ruthless people to compete with other clever and ruthless people in devising ever more efficient means of securing vast fortunes without having to dirty their hands with anything you might mistake for honest work.

  18. #18 RBH
    October 24, 2008

    Roman wrote (with rvs agreeing) that

    In general, I agree that the credit derivatives market could use some regulation. For example, an exchange for CDS contracts is a good idea and will probably happen some time in the future.

    As a long-time professional trader on regulated markets (no OTC), I see that as slightly off the mark. An exchange is not the point, it’s having a participant-funded clearing corporation standing between buyers and sellers that’s worth considering. One of the reasons we have declined to trade outside the regulated markets is the lack of a clearing corp or even (in some of the swaps markets) an agreed standard method of settlement. There was (and is) too much unquantifiable risk to make that game worthwhile in the long haul. That’s in part what the recent events are telling us loud and clear.

  19. #19 Roman Werpachowski
    October 24, 2008

    “An exchange is not the point, it’s having a participant-funded clearing corporation standing between buyers and sellers that’s worth considering.”

    That was my implicit assumption.

  20. #20 jim
    October 24, 2008

    If I collect premium on a naked call and the security gets called I have to cough up the security. (I have never done this – written a naked call, nor would I, very risky) The wire house would make sure I did. I guess if I am the institution I don’t have to make good on my contractual obligations. The people at the top should be shot.

  21. #21 Roman Werpachowski
    October 25, 2008

    “I guess if I am the institution I don’t have to make good on my contractual obligations.”

    You do. That’s why all these banks got into trouble. If they could just walk away from their obligations, they wouldn’t have the problems they have.

  22. #22 Pat Cahalan
    October 25, 2008

    > There’s a whole lot of fake wealth – stuff that’s
    > created by piling up levels of “wealth” that are
    > based on absolutely nothing at the bottom.

    It’s turtles all the way down!

  23. #23 rvs
    October 25, 2008

    @RBH

    actually, I’m with you 100%, which is why I used e.g. rather than i.e. when I mentioned exchanges. Exchanges are only one way of achieving the trust that the market needs. The big things that need to be dealt with in these markets are daily mark-to-market and posting of margin transparently (i.e. in such a way that everyone can see it and see that it isn’t double pledged). This would essentially have solved all of the problems that are now killing the credit market. Although it would probably have done it by bankrupting a number of financial institutions that are now being kept alive (*cough* Morgan Stanley *cough*).

    Anyway, none of these problems really have anything to do with CDS, which was the point I was trying to make and which is the fundamental flaw of Mark C-C’s post. Succinctly, CDS actually do the same thing for bonds that commodity futures do for commodities, i.e. provide much-needed liquidity for an illiquid market. It takes a lot of hard thought to see why, but it’s an economic truth nonetheless.

    If you don’t believe me about CDS, do a thought experiment around the original post where you are long a mortgage (or more appropriately a corporate bond) and short the matching treasury. Assuming you have good collateral posted all around, this is a synthetic CDS position, equivalent in all material aspects to owning a CDS.

    When Mark notes that it’s hard to believe anyone ever thought this was a good idea, he’s ignoring the fact that you have always been able to do it and that people have been doing exactly this via the repo markets for a long time, they just couldn’t do it conveniently in one trade. Once again, the problem is not the instrument, it’s the market. Clean that up and the instrument is an extremely useful method for investing in particular forms of risk.

  24. #24 rvsr
    October 25, 2008

    @roman on October 24, 2008 3:08 AM

    “guys I’m familiar with are staying in the series 9 iTraxx tranches and not rolling because there’s not enough liquidity.”

    > Really? I will check it, sound surprising to me.

    more clearly, I was having a discussion a few weeks with a friend of mine who is quite active in this market. His direct comment was that he had not rolled his iTraxx positions from series 9. the reason given was that the main reason for the index tranches to exist was that it allowed dealers to efficiently hedge their CSO positions. Since the CSO market has been dead for the past year, volumes in the tranches since series 9 have been way down. However, those dealers still have to hedge their previous CSO deals, which have expirations matching the various series 9 maturities, so the volumes in series 9 have been about the same. it sounded reasonable to me, and I repeated that here, but I have no direct knowledge of these market conditions.

  25. #26 AntiquatedTory
    November 5, 2008

    See, this is what I love about the Internet. I wasn’t sure about Mark’s OP–as he says, it isn’t really his subject–and then Roman, rvs etc come in and give a more expert picture. This is the glory of blogs: they enable the non-expert to engage with the expert in a way that was not really possible before. (The horror of blogs of course is that so many are echo chambers or battlegrounds for ideologues.)

  26. #27 Hank Roberts
    November 16, 2008

    For reference, worth keeping:

    The vapor merchants in action, here on video — one person warning about what’s coming (and what’s yet to come), and being dumped on, and predicting more that’s happened since, and being dumped on. Cassandra, illustrated.

    Some clips (10 min.) from 2006 and 2007 with Schiff’s predictions …

    http://econvideo.blogspot.com/2008/11/peter-schiff-retrospective-on-fox-news.html

  27. #28 Hank Roberts
    April 20, 2009

    Oy. Warned in 1995:

    What’s New by Bob Park – Friday, March 10, 1995
    http://bobpark.org/WN95/wn031095.html

    2. ARE DERIVATIVE-CRAZED PHYSICISTS RUNNING AMOK ON WALL STREET?
    Derivative trading bankrupted one of the richest counties in the nation, it destroyed the oldest bank in England and some think it could bring down the world banking system. Who’s responsible for this mess? Physicists ….

  28. #29 Hank Roberts
    June 12, 2009

    Oboy. This is just too good:

    http://www.econbrowser.com/archives/2009/06/how_to_lose_on.html

    “… little Amherst Holdings of Austin, Texas was happy to sell the big guys like J.P. Morgan Chase, Royal Bank of Scotland, and Bank of America something like $130 million notional CDS on a $27 million credit event, used the proceeds to buy off and make good the underlying subprime loans, and pocketed $70 million or so for their troubles. The big guys, on the other hand, paid perhaps a hundred million and got back zip.

    Said big guys, naturally, are screaming bloody murder, trying to bring in the lawyers to show that Amherst wasn’t playing by the rules of the game….”

    Pointer is to: http://online.wsj.com/article/SB124468148614104619.html

  29. #30 Hank Roberts
    July 14, 2009

    “… By September [2009], investors will be able to make bets on the creditworthiness of a basket of 15 Western European countries via a new index, the Markit iTraxx SovX Western Europe index. They can already buy and sell credit-default swaps on individual countries ….”

    WSJ JULY 14, 2009, 2:57 P.M. ET
    Justice Department Probes Credit-Derivatives Market

  30. #31 Redtide
    January 13, 2010

    I just cannot believe how stupid and how crooked some of the people are in this board, this is clearly a fraud and scam and yet they cannot see simply just because they are some silly laws governing CDS.

    The fact that seller of CDS can sell u insurance without the ability to pay itself is a scam. regardless how the laws want to put it