First, Happy Thanksgiving.
Second, I’d like to share a story from Bloomberg, which I confess I do not entirely understand.
Bloomberg reports that Goldman Sachs, Citigroup (the company that just got federal support for $306 billion of its assets) and JPMorgan Chase “are among banks offering wagers on the amount investors may recover from bonds after borrowers go bankrupt.”
These same companies helped expand the $47 trillion market for credit default swaps, which are promises to reimburse an investor for loss on a bond. Credit default swaps are basically insurance, but they aren’t called insurance, so they aren’t regulated — at least that’s what critics say. Insurance giant AIG failed partially because it issued billions of dollars worth of credit default swaps.
Here’s what Bloomberg says the financial wizards are up to now…
Credit-recovery swaps are trading on the debt of about 70 companies, including automaker General Motors Corp. and bond- insurer MBIA Inc. That’s up from 40 during the summer, according to Mikhail Foux, a strategist at Citigroup in New York.
The contracts, barely traded in 2006, are now worth about $10 billion as more companies fail to repay debts, Foux said. Also known as recovery locks, the agreements are bought as insurance by sellers of credit-default swaps, such as banks, hedge funds and insurers.
“The market definitely has potential to grow,” Foux said. “As we see more defaults — and there’s no doubt we’re going to see more defaults — you’re going to see more recovery swaps trading.”
Goldman Sachs and JPMorgan officials declined to discuss their role in the market.
Here’s the thing: It’s sensible for an owner of an asset to hedge against the risk the asset will lose value. The problem with credit default swaps was that the buyer didn’t need to own the asset. So the swaps became ways for investors to gamble on market trends or on companies. Also, since the swaps are unregulated; details are murky, which adds to confusion.
It’s not clear to me from this Bloomberg story what the rules are around the newer recovery swaps. Are they a legitimate hedge, or more gambling? Read the story HERE and post your comments.
And in other mortgage news…
- Fed plan should stem credit-card crunch
- Group calls for 180-day foreclosure moratorium
- O.C. mortgage rate drop a “miracle”
- Fed to pump $800 billion into credit markets
- Downey Financial to file for bankruptcy after government seized assets
- Citigroup bailout “an outrage”
- Citigroup gets a bailout
- Wells Fargo to cut mortgage jobs in Irvine
- Downey Savings seized by regulators
- A ‘good’ borrower these days is someone who…
- Happy holidays: Freddie, Fannie halt foreclosures till 2009
- FDIC pushes IndyMac model for troubled mortgages
- 39% of O.C. home sales are foreclosures
Financial “Technology” is a crock. These insturments: credit default swaps, credit debt obligations, and other derivatives made the housing correction into a global nightmare. Hopefully, when we come out of this mess we are a little wiser. One last thing, if you see the words like “Innovation” and “Engineering” making phrases with the word “Financial” (i.e. “FInancial Engineering” or “Financial Innovation”) run!!!!
Happy Thanksgiving!
Sounds like more gambling to me. All those MBAs on Wall St. need to keep busy, so they apparently sit around inventing new derivatives.
Although I first thought it odd that anyone could buy a CDS, even if they didn’t own the underlying debt security, and that is usually cited as one of the big problems with CDSs in general, I no longer believe that necessarily. For example, if you want to bet on the value of the S&P 500 on December 31, and I agree to take your bet, neither of us has to own any stocks in that index. Of course, in this case, you are truly betting, and not hedging, because you have no exposure to stocks to hedge.
The bigger problem is lack of regulation. If I’m free to take as many of these bets as I want, even though I can’t pay off on them, then there’s a problem. Normally, I would just go bankrupt, and all the people I took bets from could line up in court to try and recover some of their money. But, if my bankruptcy threatens to create a domino effect, then the govt will “have to” step in and backstop me.
“Potential to grow” versus “no doubt we’re going to see more defaults”
So which one is it?
Financial Innovation: For myself, I have a “sweep” account, a floating rate 15yr mortgage, an ATM card, and pay my bills on-line. These are all financial innovations, so…
Innovation is not a bad thing.
The Gov’t Flushing $700B down the drain IS bad:
The Gov’t should NOT be poring good money into failed institutions ( AIG alone is $150Billion last time I looked). So, now we have legislators stumbling into a mess they have no experience dealing with — and will only manage to make worse. Bankruptcy laws are there for a reason. Let institutions suffer the consequences of their mistakes.
These are no different than the options market, except that there’s no regulated exchange at this time.
Since nobody knows where the risk in CDS’s are right now, it’s creating a lot of anxiety for investors. A regulated market with full disclosure would solve all of this.