Will Government Do Away with CDSs?
By Fil Zucchi Nov 19, 2008 11:00 am
Senate seems on the verge of violating contract clause.
In October, Minyanville CEO Todd Harrison discussed the tools -- legitimate or otherwise -- that the government may have to wipe out speculative CDSs.
I’m raising my antennae high for any more chatter that the government may in fact try to reach into that toolbox. Let's be honest here: Senators wouldn’t recognize a CDS if they woke up next to one, so the mere notion that one of them would question the "value to society" of a naked CDS suggests that someone in the financial business is whispering in our senators' ears that -- in true socialist spirit -- the Feds are perfectly within their powers to "technically" do what the Contract Clause of our Constitution expressly prohibits.
So what if we did wake up to a world in which AIG (AIG) was made solvent again by the waving of a magic congressional wand? It’s not unthinkable that the market may have a sharp move higher, let's say... 50%?
And yet, while that will put most bears permanently out of business and make our federal government heroes worthy of a new pantheon, chances are -- when the populist euphoria wears off -- our leaders will have grown so much in myth that we’ll have abdicated just about everything to them. Ultimately this evisceration of our private markets will, well, eviscerate them - and what seemed like a good idea at the time will be the bane of generations to come.
Do I sound like some wacky libertarian? Yeah, there may be a tinge of that. But how many people outside the 'Ville tossed around the possibility of a Great Depression a mere 24 months ago?
Let's hope for the best - but let's not get caught with our pants down should the worst come to pass.
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2008-11-19 14:11:06
Contracts
So if I were to start selling financial derivatives based on say the middle 3 digits of the jobs number or the winner of the kentucky derby or the point spread of Monday's football game, that would be all right and it would be an interference with contracts to throw me in the slammer?
Are these naked CDS different than an online casino? If so, how?
Are these naked CDS different than an online casino? If so, how?
2008-11-19 17:18:29
investment advice
Raises hand. I did and have been continuing to state that these next three years are going to make the entire First Great Depression look like a bad day at the dog track. Just number wise we have exponentially more people then we did in 1929. Each of those people will represent one set of Maslow's Heirarchy of Needs. This isn't a down turn in the market, this is the end of the market and the end of our way of doing business. We had an economic engine that was predicated upon unlimited growth. Take that out of the equation and the whole thing is a bust.
2008-11-19 17:30:35
A Sometimes Useful Risk Management Tool
Let's assume that I am a materials vendor to a privately-held auto parts manufacturer. That customer routinely runs large accounts payable balances with me, which can represent 90 days of sales. Let's further assume that this is a large, important client.
Concerned about the health of the auto industry and facing business failure if this client were to default, I wish to hedge my credit risk. I cannot short the debt or equity of my customer since it is privately held. I can, however, purchase a CDS(s) on other parts manufacturers or the auto makers to hedge this risk. Not a perfect hedge but better than nothing.
This is but one example of the use of the CDS other than speculation.
Concerned about the health of the auto industry and facing business failure if this client were to default, I wish to hedge my credit risk. I cannot short the debt or equity of my customer since it is privately held. I can, however, purchase a CDS(s) on other parts manufacturers or the auto makers to hedge this risk. Not a perfect hedge but better than nothing.
This is but one example of the use of the CDS other than speculation.
2008-11-19 17:33:30
Contracts
Interesting derivative contracts you've designed.. lol. But seriously.. a CDS serves as "insurance" against the bond issues of a company, by design. It can also serve as somewhat of a hedge against more generalized counterparty risk. A portfolio of these contracts, properly constructed, could serve as a hedge against the failure of entire sectors - big "money center" banks, for example. So I assert that yes, CDSs, even those in excess of the nominal value of bonds issued by an entity, do have some economic purpose.
2008-11-19 18:12:48
Contracts Clause
Sorry to burst your bubble (don't you wish that Greenspan had been willing to burst a few bubbles?), but the Contracts Clause only applies to the States. Even the Takings Clause does not reach so far as to prevent Congress from vitiating contracts. Congress has the power to outlaw derivatives contracts in interstate commerce, particularly where there is no underlying ownership of an asset. Think about a contract on whether two dice will come up 7 or 11, or come up seven before the first number comes up a second time. Congress has the power to make that contract, in interstate commerce, illegal. Same with a derivatives contract. So what's your remedy? Persuade your Rep and Senators that CDSs' benefits outweigh their risks to society. And good luck with that.
2008-11-19 18:26:41
Cecchi and Pickrell misunderstand the definitions of risk.
* Insurance transfers already-existing risk.
Gambling fabricates risk where there is none, without creating economic value.
Venture capital creates risk, and economic value as well.
Thus we allow insurance and venture capital, but may choose to disallow gambling.
Take that a step further. IF we limit insurance as a deal between a party currently at risk and a professional risk-assumer, then we will destroy liquidity in the marketplace.
There are only a few farmers and bakers, not nearly enough to create a deep orderly and liquid wheat market. Whither price discovery? I suppose "mark-to-market" is in such deep disfavor we see no more need for markets, to which to mark.
* Insurance transfers already-existing risk.
Gambling fabricates risk where there is none, without creating economic value.
Venture capital creates risk, and economic value as well.
Thus we allow insurance and venture capital, but may choose to disallow gambling.
Take that a step further. IF we limit insurance as a deal between a party currently at risk and a professional risk-assumer, then we will destroy liquidity in the marketplace.
There are only a few farmers and bakers, not nearly enough to create a deep orderly and liquid wheat market. Whither price discovery? I suppose "mark-to-market" is in such deep disfavor we see no more need for markets, to which to mark.
2008-11-20 00:24:32
Antonin Scalia on the Contract Clause
Quotation is from address delivered on September 16, 1988 at the University of Cincinnati as the William Howard Taft Constitutional Law Lecture.
"I think it highly probable that over the past two hundred years the Supreme Court, though not avowedly under the banner of "nonoriginalist" interpretation, has in fact narrowed the contract clause of the Constitution n28 well short of its original meaning. "
Scalia once referred to the Contracts Clause as being an example of a Constitutional dead letter while speaking from the bench to his fellow justices, as I recall. He was referring to the damage already done to the Constitution by non-originalist interpretation and used the essentially moot Contracts Clause as an example.
If the Contracts Clause were still in effect then labor unions would be much less powerful, and, likely, we would not be looking at the end of the Detroit automakers.
Detroit will soon be followed by the rest of strongly unionized manufacturing, I believe. Boeing will likely spin off commercial aerospace as real competition comes on line and become a pure defense contractor (which as a group will remain unionized).
"I think it highly probable that over the past two hundred years the Supreme Court, though not avowedly under the banner of "nonoriginalist" interpretation, has in fact narrowed the contract clause of the Constitution n28 well short of its original meaning. "
Scalia once referred to the Contracts Clause as being an example of a Constitutional dead letter while speaking from the bench to his fellow justices, as I recall. He was referring to the damage already done to the Constitution by non-originalist interpretation and used the essentially moot Contracts Clause as an example.
If the Contracts Clause were still in effect then labor unions would be much less powerful, and, likely, we would not be looking at the end of the Detroit automakers.
Detroit will soon be followed by the rest of strongly unionized manufacturing, I believe. Boeing will likely spin off commercial aerospace as real competition comes on line and become a pure defense contractor (which as a group will remain unionized).
2008-11-21 23:09:06
Risk
I think I understand the definition of Risk. How is betting on the value of corn in July, or the value of a bond in 2010 when I have neither corn nor bond different from betting on the score of the superbowl or the middle 3 digits of the weekly jobs report?
Perhaps in some views some bets have economic value while others don't but to me they are all gambling. And of course there is no federal law against gambling except perhaps that on the internet.
Perhaps in some views some bets have economic value while others don't but to me they are all gambling. And of course there is no federal law against gambling except perhaps that on the internet.
2008-11-23 23:45:12
Government CDS
I agree completely. The gov't is getting way to involved in areas of business that they should not be. Everything the government gets into gets destroyed and then our childrens children will end up having to pay the bill.
I believe the depression is coming and when the democrats take power, it will be coming faster than ever.
The Government needs to do their jobs and let the free market do what it needs to, to get back on track. The realestate market bubble collapsed because the Government made it into a bubble with the forcing of banks to make bad loans.
The government is in place for protection not control and dependency.
I believe the depression is coming and when the democrats take power, it will be coming faster than ever.
The Government needs to do their jobs and let the free market do what it needs to, to get back on track. The realestate market bubble collapsed because the Government made it into a bubble with the forcing of banks to make bad loans.
The government is in place for protection not control and dependency.
2008-11-26 17:56:35
Government CDS
Checchi says: "Perhaps in some views some bets have economic value while others don't but to me they are all gambling."
...thereby disallowing. or at least trying to marginalize, the notion of market-maker / liquidity provider.
Go back to the shift from loans to debt. The issuer wants long term money. The investor wants an out. A third party undertakes to buy from one investor and sell to another, thereby creating time for the issuer, and liquidity for the investors. No one would issue securities without first having a market-making function.
So to with CDS. If I wish to express an opinion on a credit, in the only way that counts (i.e. with money) then I must be able to go long or short. If I cannot do that absent the actual debt instrument, then there is no price discovery.
...thereby disallowing. or at least trying to marginalize, the notion of market-maker / liquidity provider.
Go back to the shift from loans to debt. The issuer wants long term money. The investor wants an out. A third party undertakes to buy from one investor and sell to another, thereby creating time for the issuer, and liquidity for the investors. No one would issue securities without first having a market-making function.
So to with CDS. If I wish to express an opinion on a credit, in the only way that counts (i.e. with money) then I must be able to go long or short. If I cannot do that absent the actual debt instrument, then there is no price discovery.
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