France Finance Minister : Need changes on CDS sovereign risks rules

Discussion in 'Wall St. News' started by ASusilovic, Feb 12, 2010.

  1. …the backlash against those nasty conspiratorial financial speculators who have caused all this sovereign debt crisis stuff, that is.

    The following quotes come from a Newsnight interview with Christine Lagarde, France’s finance minister.

    She was asked what message she would like to send to speculators. To which she replied:

    “They’d better be careful there is clearly a statement of solidarity, we are closing ranks , big or small member states, we are all in this together, and not going to let any of us down”.

    “What we are going to take away from this crisis is certainly a second look at the validity , solidity of cds on sovereign risk, and clearly we need to look deeply into that and propose changes.”

    “It confirms our determination to actually to bring more transparency into this equation.”

    Those changes, we guess, will probably include some ham-fisted attempt to ensure that buyers of protection have some “skin in the game” – i.e. own the underlying sovereign security.
  2. CDS is akin is naked short-selling.

    9 people take out fire insurance on 1 house.

    With CDS, there's no insurable interest. That's known as fraud, in other industries.

    I don't have a problem with speculation. I make my living from it.

    The problem - when financial instruments compound losses. Not diversify risk.

    In the event of default, CDS compounds losses because there's more protection buyers than outstanding underlying.

    As a taxpayer, this means I'm forced to shell out a few trillion to cover JPM's short CDS portfolio, in the case of a PIIGS default.

    Why should the American or European taxpayer do that?

    In fairness, if moral hazard was done away with, CDS is fine.

    With no moral hazard, all the speculative banks that wrote protection get liquidated, most of the protection buyers get stiffed (pennies on the dollar), and the banking giants get swept away only to have their smaller, better capitalized brethren, rise and take their place.

    That's how capitalism is supposed to work. Creative destruction.

    Let AIG fail, and watch Goldy, BoA and the rest of the crew go packing. Evidently, the same guys that played a huge role in the crisis. Seems Washington values lobbyists, influence and donations (read: bribes) more than free-market capitalism.

    The lesson? End Moral hazard or regulate CDS 1:1 to the underlying.

    Next step? Put a true Constitutional-Libertarian in the Whitehouse.
  3. That's interesting you're comparing it to naked short selling...

    Does the price of a CDS determine the price of the bond for that country's debt? Because if it's true, then taking too many CDS insurance on the debt would increase the perceived default risk, and thus increase the financing costs of the debt.

    The next step is to force the government to sell parts of its assets since it can't finance the debt anymore, and then you (same bank or hedge fund that shorted the CDS) scoop up the assets on the cheap.

    The problem is that so far the countries that are affected seem to have a REAL default risk, not manufactured by naked shorting.

    A little story: There was talk of regulating derivatives. One of the options was of putting them on a public exchange. The benefits are obvious, you eliminate counter party risk. Apparently other companies like airlines didn't like that, because they are a user of OTC derivatives for real business purposes. But why wouldn't real businesses want derivatives transparent? Their reason can't be good, think up your own. Tax evasion, executive compensation, or just good old information leakage?

    And so the derivatives on public exchanges initiatives appears to have been defeated, not by Wall Street, but by Corporate America. That's the *status* of change in America, deadlocked. The whole country is in dire straights...