Comments on: So Do CDS Counterparties Post Collateral or Not? http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html Sun, 22 Nov 2009 11:45:14 -0500 http://wordpress.org/?v=2.8.4 hourly 1 By: jmd http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-28000 jmd Wed, 03 Dec 2008 03:48:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-28000 CDS are not the problem...nor is portfolio-margining...the problem is that the desks taking on risks have had no effective controls from their rah-rah credit officers and risk managers for the past 5+ years. CDS are not the problem…nor is portfolio-margining…the problem is that the desks taking on risks have had no effective controls from their rah-rah credit officers and risk managers for the past 5+ years.

]]> By: tomd http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27996 tomd Wed, 03 Dec 2008 03:31:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27996 S<br/>Thanks for the reference to the itulip piece. If correct, it greatly facilitates my understanding of the centrality of CDS to the current mess. That CDS is of central importance, I have no doubt. I agree with IRA on that. But heretofore, I had thought it was the speculative use of CDS unrelated to an underlying credit that was the real issue; that and the lack of initial margin posted by the major players. The itulip piece helps me understand why interbank lending has ground to a halt: they all know that at their core they are all rotten because of the immense amount of loans they made only because they had the (now seen as illusory) protection of CDS.<br/>Would be interested in what Yves thinks of the itulip piece.<br/>TomD S
Thanks for the reference to the itulip piece. If correct, it greatly facilitates my understanding of the centrality of CDS to the current mess. That CDS is of central importance, I have no doubt. I agree with IRA on that. But heretofore, I had thought it was the speculative use of CDS unrelated to an underlying credit that was the real issue; that and the lack of initial margin posted by the major players. The itulip piece helps me understand why interbank lending has ground to a halt: they all know that at their core they are all rotten because of the immense amount of loans they made only because they had the (now seen as illusory) protection of CDS.
Would be interested in what Yves thinks of the itulip piece.
TomD

]]> By: Anonymous http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27991 Anonymous Wed, 03 Dec 2008 01:51:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27991 The plot with collateral thickens as each bank (as previously stated) has "netting" agreements by legal entity across all products with their counterparties. Hence 5 long and 5 short = 0 w/ counterparty a. Key issues that have historically muddied the water beyond confirmation delays have been the ability to "novate" positions away from conterparty a without counterparty a's knowledge hence 5 - 5 does not equal zero. Further muddying the water is the fact that most IB's look at their portfolios using a very high level aggregate risk analysis that also nets longs/shorts .... the old saying " clever by half" is really the more appropriate way of looking at many of these transactions. For Wall Street Banks these products have been a tremendous fee generator without any of the balance sheet funding implications (i.e, capital funding or regulatory capital). Forget expecting collateral to compensate for the scale and madness of these products. The real pain of these products lies in their "Heisenberg-like" qualities ... on equity prices and overall firm stability. Naughty, naughty, naughty.<br/><br/>Mike S ... NJ Earth The plot with collateral thickens as each bank (as previously stated) has “netting” agreements by legal entity across all products with their counterparties. Hence 5 long and 5 short = 0 w/ counterparty a. Key issues that have historically muddied the water beyond confirmation delays have been the ability to “novate” positions away from conterparty a without counterparty a’s knowledge hence 5 – 5 does not equal zero. Further muddying the water is the fact that most IB’s look at their portfolios using a very high level aggregate risk analysis that also nets longs/shorts …. the old saying ” clever by half” is really the more appropriate way of looking at many of these transactions. For Wall Street Banks these products have been a tremendous fee generator without any of the balance sheet funding implications (i.e, capital funding or regulatory capital). Forget expecting collateral to compensate for the scale and madness of these products. The real pain of these products lies in their “Heisenberg-like” qualities … on equity prices and overall firm stability. Naughty, naughty, naughty.

Mike S … NJ Earth

]]> By: S http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27966 S Tue, 02 Dec 2008 20:31:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27966 Very interesting take on CDS and bank reserves...banks used cds to expand balance sheets and thus no way to unwind the market without bankrupting the banks. The increase in reserves is exploding becasue the patient is dead..the capital holes are so enormous<br/><br/>http://www.itulip.com/forums/showthread.php?p=63569#post63569 Very interesting take on CDS and bank reserves…banks used cds to expand balance sheets and thus no way to unwind the market without bankrupting the banks. The increase in reserves is exploding becasue the patient is dead..the capital holes are so enormous

http://www.itulip.com/forums/showthread.php?p=63569#post63569

]]> By: ccm http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27961 ccm Tue, 02 Dec 2008 19:31:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27961 David Murphy: <i>The vast majority of inter-dealer CDS are done under ISDA masters that cover all derivatives dealing between the counterparties, so net margin is posted on the entire portfolio of equity, credit, interest rate and commodity derivatives between the counterparties.</i><br/><br/>If you read the whole of the IRA's post, you will find that this is precisely the situation that the IRA is worried about. There are two problems:<br/><br/>(i) posting collateral on the net portfolio obligation in no way guarantees that an institution has the liquidity to cover obligations on a specific default. We need to remember that CDS values "jump" by design -- i.e. the actual event of default is all but guaranteed to precipitate a large change in value. While the market handled Lehman well, the market could not possibly have had more warning signs of that default -- Lehman's problems had been leading the business section of the news for months.<br/><br/>(ii) Given the valuation problems for even plain vanilla derivatives right now (see vlade), how is it within anyone's imagination that the net margin posted as per ISDA protocols is meaningful? The ISDA is getting a good bite in the butt from it's implicit reliance on the efficient markets theory.<br/><br/>Every single major collapse was precipitated by interdealer margin calls: Bear, Lehman, AIG. And we probably just haven't heard about Citi yet. While the press hasn't connected these margin calls with CDS (except in the case of AIG) and the ISDA agreement probably prevents the margin calls from being attributed to any specific type of derivative, I think the IRA is just reading the writing on the wall. David Murphy: The vast majority of inter-dealer CDS are done under ISDA masters that cover all derivatives dealing between the counterparties, so net margin is posted on the entire portfolio of equity, credit, interest rate and commodity derivatives between the counterparties.

If you read the whole of the IRA’s post, you will find that this is precisely the situation that the IRA is worried about. There are two problems:

(i) posting collateral on the net portfolio obligation in no way guarantees that an institution has the liquidity to cover obligations on a specific default. We need to remember that CDS values “jump” by design — i.e. the actual event of default is all but guaranteed to precipitate a large change in value. While the market handled Lehman well, the market could not possibly have had more warning signs of that default — Lehman’s problems had been leading the business section of the news for months.

(ii) Given the valuation problems for even plain vanilla derivatives right now (see vlade), how is it within anyone’s imagination that the net margin posted as per ISDA protocols is meaningful? The ISDA is getting a good bite in the butt from it’s implicit reliance on the efficient markets theory.

Every single major collapse was precipitated by interdealer margin calls: Bear, Lehman, AIG. And we probably just haven’t heard about Citi yet. While the press hasn’t connected these margin calls with CDS (except in the case of AIG) and the ISDA agreement probably prevents the margin calls from being attributed to any specific type of derivative, I think the IRA is just reading the writing on the wall.

]]> By: S http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27955 S Tue, 02 Dec 2008 18:59:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27955 The LEH CDS settle is a false flag operation by the Fed to send a signal to the market that "nothing to see here." It has worked, it would appear, but for the blogs. It is virtually the equivilant to Wells Fargo raising its dividend into the short rule as it modified the way it records charge offs / delinquencies. <br/><br/>We could clear it up if we new what collateral the Fed held? Waiting for the bloomberg FIA request to come through....and waiting... The LEH CDS settle is a false flag operation by the Fed to send a signal to the market that “nothing to see here.” It has worked, it would appear, but for the blogs. It is virtually the equivilant to Wells Fargo raising its dividend into the short rule as it modified the way it records charge offs / delinquencies.

We could clear it up if we new what collateral the Fed held? Waiting for the bloomberg FIA request to come through….and waiting…

]]> By: ndk http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27953 ndk Tue, 02 Dec 2008 18:26:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27953 <i> But a friend is arguing that the supply is way down as foreign banks are going under.</i><br/><br/>A lot of shops selling vol and insurance have been under, shall we say, mild stress recently. The governments have decided to backstop to every financial firm in the world while running 10% of GDP deficits. Chicken, egg, who knows, but I tend to blame the chicken. But a friend is arguing that the supply is way down as foreign banks are going under.

A lot of shops selling vol and insurance have been under, shall we say, mild stress recently. The governments have decided to backstop to every financial firm in the world while running 10% of GDP deficits. Chicken, egg, who knows, but I tend to blame the chicken.

]]> By: kridkrid http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27952 kridkrid Tue, 02 Dec 2008 18:12:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27952 I have a question that may not necessarily fit here, but how do people account for the recent increase in the US Treasury 10-year CDS price? It's at 68.4 basis points as of yesterday, up from 2 in July of 2007. <br/><br/>Now the easy answer is that the likelihood of default has increased substantially through the bailouts and anticipated future stimulus. But a friend is arguing that the supply is way down as foreign banks are going under. But if the risk is limited, what would prevent other banks from picking up that slack? My position is the price increase is based almost entirely upon an increase in demand and increase perceived risk. His position is that the supply is way down. One right, one wrong? Both right? What do people think? I have a question that may not necessarily fit here, but how do people account for the recent increase in the US Treasury 10-year CDS price? It’s at 68.4 basis points as of yesterday, up from 2 in July of 2007.

Now the easy answer is that the likelihood of default has increased substantially through the bailouts and anticipated future stimulus. But a friend is arguing that the supply is way down as foreign banks are going under. But if the risk is limited, what would prevent other banks from picking up that slack? My position is the price increase is based almost entirely upon an increase in demand and increase perceived risk. His position is that the supply is way down. One right, one wrong? Both right? What do people think?

]]> By: Anonymous http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27942 Anonymous Tue, 02 Dec 2008 15:44:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27942 If banks don't require margining of CDS contracts that's news to me. I feel like an idiot for posting collateral every morning when they call for it. For every contract there is an initial haircut, used to be as low as 1% of the notional but is much higher now. Plus 100% of the current exposure of course. These indeed are updated every day by every counterparty. People used to be lackadaisical about margin but I guarantee every credit officer who wants to keep his job is watching their margin requirements like a hawk. Call it early and often is the new manta. If banks don’t require margining of CDS contracts that’s news to me. I feel like an idiot for posting collateral every morning when they call for it. For every contract there is an initial haircut, used to be as low as 1% of the notional but is much higher now. Plus 100% of the current exposure of course. These indeed are updated every day by every counterparty. People used to be lackadaisical about margin but I guarantee every credit officer who wants to keep his job is watching their margin requirements like a hawk. Call it early and often is the new manta.

]]> By: albrt http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post.html#comment-27939 albrt Tue, 02 Dec 2008 15:19:00 +0000 http://www.nakedcapitalism.com/2008/12/so-do-cds-counterparties-post-collateral-or-not/#comment-27939 The thing that is stunning to us outsiders, and that the insiders seem to take for granted, is that the collateral isn't posted until after something bad happens to change the valuation formula. Which, of course, is the same time the counterparty is least likely to be able to post collateral due to the bad things that are happening.<br/><br/>On the positive side, you have given me an idea for a similar arrangement next time I refinance my mortgage - I will simply promise to execute a deed of trust after I default. That way I can use the house as collateral for other things in the mean time. This should be completely legal and acceptable as long as my models show I am not likely to default. The thing that is stunning to us outsiders, and that the insiders seem to take for granted, is that the collateral isn’t posted until after something bad happens to change the valuation formula. Which, of course, is the same time the counterparty is least likely to be able to post collateral due to the bad things that are happening.

On the positive side, you have given me an idea for a similar arrangement next time I refinance my mortgage – I will simply promise to execute a deed of trust after I default. That way I can use the house as collateral for other things in the mean time. This should be completely legal and acceptable as long as my models show I am not likely to default.

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