As Europe all but begs the U.S. to put a saddle on Wall Street speculation, is it becoming even more apparent that the status quo has decided otherwise?
We learn from The U.K. Guardian, over the past 48 hours--since it's becoming rather obvious to this diarist that the US business press and MSM are not properly covering this story--Europe is miles beyond being just fedup with Wall Street casino capitalism. The European Union (EU) is now as serious as a heart attack as far as their latest considerations are concerned as they relate to the EU's implementation of an outright ban on some forms of derivatives across the continent; and, Greek Prime Minister Papandreou visited the White House late Tuesday to personally ask President Obama to support a crackdown on Wall Street speculators, specifically requesting U.S. support for a ban on naked credit default swaps, at least as they pertain to sovereign debt, and implementation of related market controls on investment vehicles applicable to shorting (i.e.: "betting" on downward market movements) foreign currencies.
Regrettably, exacerbating the problem, it appears that American media outlets are all but going out of their way to confuse the story, which ultimately--at least to this diarist--boils down to the U.S. supporting the European-driven effort to prevent Wall Street speculation, at least as it relates to their respective economy(ies).
If you follow the Wiki link to "naked credit default swaps," in the opening paragraph, you'll learn that, essentially, what makes a credit default swap a naked credit default swap is when the purchaser does not own the underlying investment on which it's attempting to buy the "hedge" (i.e.: the "insurance").
(As Greek Prime Minister Papandreou frames it in an article, linked below, "It is common sense, enforced by insurance regulators, that a person is not allowed to buy fire insurance on his neighbour's house, and then burn it down to collect on that insurance.")
Papandreou's visit aside, we also now know--since you won't be reading too much in the Wall Street Journal or on Bloomberg about this here in the U.S.--that, over the past year, most European countries have already tacitly banned the previously-dominant, major U.S. investment houses from most sovereign finance deals on the continent.
Indeed, Wall Street behemoths such as Goldman Sachs, Morgan Stanley and JPMorgan Chase find themselves reviewing their performance in Europe during 2009 and realizing they're no longer the predominant players on the "A"-list of top dealmakers when it comes to European sovereign debt.
Goldman-Sachs disputes the Guardian's findings, claiming it is actually fourth on the list, once "dollar-denominated deals" are figured into the mix. (I would speculate that Goldman's "deals" include significant amounts of naked credit default swaps transactions, and this is something I discuss further, below.) Meanwhile, here's the Guardian from Monday...
Europe bars Wall Street banks from government bond sales
Elena Moya
guardian.co.uk, Monday 8 March 2010 21.36 GMT
European countries are blocking Wall Street banks from lucrative deals to sell government debt worth hundreds of billions of euros in retaliation for their role in the credit crunch.
For the first time in five years, no big US investment bank appears among the top nine sovereign bond bookrunners in Europe, according to Dealogic data compiled for the Guardian...
--SNIP--
..."Governments do not have the confidence that the excessive risk-taking culture of the big Wall Street banks has changed and they still cannot be trusted to put the stability of the financial system before profit," said Arlene McCarthy, vice chair of the European parliament's economic and monetary affairs committee. "It is no surprise therefore that governments are reluctant to do business with banks that have failed to learn the lesson of the crisis. The banks need to acknowledge the mistakes that were made and behave in an ethical way to regain the trust and confidence of governments."
Bold type is diarist's emphasis.
The article continues on to tell us that, as of 2009, European banks are now dominating these deals, which are projected to amount to 500 billion dollars in 2010. It discusses recent sovereign transactions throughout Europe, and then focuses upon what's happened in Greece over the past year. We learn that Greece kept Goldman-Sachs, Morgan Stanley and numerous U.S. hedge funds away from their country's most recent bond offerings.
Petros Christodoulou, the head of Greece's debt management office, told the Guardian the bond issue had been directed to more "long-term" investors as they were seeking market stability. Greece has had tense relationships with Goldman recently after it emerged that the US bank had helped hide the real level of the country's public debt with derivatives contracts.
The Guardian tells us that Greece, Spain, Germany and France are "...pushing for changes in the credit default swap market, where investors can bet against the possible default of a country, ultimately bringing more instability."
As I mentioned it at the top of this diary, Tuesday afternoon, Greek Prime Minister Papandreou paid a visit to the White House where, according to the Guardian, he was going to seek support for his country and "....ask Obama to impose stricter regulations on hedge funds and currency traders, who they blame for aggravating their problems and making it harder for Greece to borrow money."
Greek PM to urge Barack Obama to crack down on speculators
Graeme Wearden
guardian.co.uk, Tuesday 9 March 2010 14.14 GMT
...Greek officials have indicated that Papandreou will ask Obama to impose stricter regulations on hedge funds and currency traders, who they blame for aggravating their problems and making it harder for Greece to borrow money.
--SNIP--
Last night, Papandreou warned an audience in Washington that the value of the euro could fall sharply if Greece's debt crisis escalates. He argued that a weak euro would make it harder for US manufacturers to sell goods in the eurozone, at a time when America is looking to exports to help drive its recovery from recession.
--SNIP--
"Unprincipled speculators are making billions every day by betting on a Greek default," Papandreou told the Brookings Institute.
"That is why Europe and America must say 'enough is enough' to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system - not to mention the human consequences of lost jobs, foreclosed homes, and decimated pensions," he added.
--SNIP--
Papandreou said the CDS market needed reining in, claiming that some hedge funds had tried to destabilise the Greek economy after betting that the country would default.
"It is common sense, enforced by insurance regulators, that a person is not allowed to buy fire insurance on his neighbour's house, and then burn it down to collect on that insurance," he said.
Meanwhile, while Obama met with Papandreou at the White House, the European Union all but told us that it really is about Wall Street speculation and the potentially devastating effects it is having--and could have--on numerous sovereign economies throughout the region, if not the rest of the world.
Brussels targets derivatives to help euro
Ian Traynor in Brussels
guardian.co.uk, Tuesday 9 March 2010 17.51 GMT
The European commission announced moves today to shore up the euro and ward off market pressure on Greece by considering a ban on complex derivatives allegedly being used to undermine the single currency.
George Papandreou, the embattled Greek prime minister, who has been arguing in Berlin, Paris, and Luxembourg for the past several days that unbridled speculation on the markets is driving his country towards national insolvency and sovereign debt default, was expected to lobby the White House last night to join the crackdown on the markets.
--SNIP--
...Merkel was also joined by Jean-Claude Juncker, the Luxembourg leader and head of the eurozone of 16 countries using the single currency, in demanding swift action to rein in the markets.
[European Commission President] Barroso said today it was "not justified" to buy CDSs "by unseen interventions on a risk, on a purely speculative basis ... The commission will examine closely the relevance of banning purely speculative naked sales on credit default swaps of sovereign debt."
We're told by the Guardian that this will be the front-and-center issue at the next meeting of the G20. "Merkel, Sarkozy, Juncker and Papandreou...threatened to take national action against the markets if Brussels balked." German Prime Minister Merkel was quoted as saying...
"We must discourage financial market speculation," she said. "A fast implementation in the area of credit default swaps must follow. We know this will be done on the American side too, but we think that a step ahead from our side, from the European Union, would help."
Now, here's where the waters start getting quite muddied in this story, as we see, firsthand, how the Wall Street press is handling it (or, should I say, distorting it), tonight.
Obama Can Offer Little in Talks on Greek Debt Crisis (Update2)
By Nicholas Johnston
March 9 (Bloomberg) -- Greece's debt crisis may lead to slower U.S. growth, a rising dollar and turmoil in credit markets that may make it more difficult for cash-strapped states such as California to borrow.
And as President Barack Obama met today with Greek Prime Minister George Papandreou, there's little the U.S. can do...
The reality, however, is somewhat different.
As this last (Bloomberg) story finally gets to the salient facts, Papandreou (based upon comments from none other than Secretary of State Hillary Clinton in this story) really is not looking for a U.S. bailout, at all.
He merely wants the President to support the European effort to put a saddle on Wall Street speculation (as reported in the Guardian, as well). The problem is not at the White House as much as it is at the Treasury Department, since German Prime Minister Merkel also states in the Guardian article, excerpted above this Bloomberg piece, that she knows the U.S. is going to do this.
You see, Treasury Secretary Geithner is vehemently against any controls on Wall Street as far as derivatives trading is concerned--naked swaps or otherwise (plain vanilla swaps). We know this from his 2009 testimony before Congress. Furthermore, recent legislation in the Senate all but eviscerates virtually any controls on Wall Street as far as derivatives trading is concerned. Derivatives trading--particularly naked credit defaults swaps trading--is one of the most lucrative profit centers on all of Wall Street.
It is the diarist's contention--and that of many others--that traditional credit default swaps trading has its rightful place in the financial services sector. It provides a reasonable hedge ("insurance") for a variety of business functions. But, when it comes to naked credit default swaps trading--where the buyer of the naked credit default swap is "buying an insurance policy on his neighbor's home," as Greek Prime Minister Papandreou references it--it is that which puts the word "casino" after the term, "Wall Street."
But the conflation--deliberate or driven by sheer journalistic incompetence--by the U.S. MSM on this matter is simply out-of-hand! A quick, full read of the AP coverage on this story, from the past evening, linked HERE, provides a perfect example of this seemingly deliberate confusion, as well. (Or, again, is it simply an uneducated journalist overwhelmed by the complexity of the story?) Hell, as is self-evident from their story, the AP reporter cannot even discern the difference between a credit default swap and a naked credit default swap!
But, the harsh truth is the problems in the Wall Street casino--inasmuch as they harm governments--are much more severe than just in terms of how they're adversely affecting sovereign debt. You see, when you look at the list of the 1,000 most highly-traded credit default swaps, linked HERE, and pass through the gateway page, and select Table 6 from the Top-1000 list, you'll see the States of California, Florida, New Jersey, New York and Texas, as well as New York City, on this list, too!
Yes, today on a Wall Street bereft of any significant regulatory controls on derivatives trading, you may place your bets on a naked credit default swap with any party willing to book it, even if it is a bet against a U.S. state or city. And, if you have ANY doubts about Wall Street's willingness to put their money up against the well-being of the American public, just read these two links (since it's fully documented fact that Goldman-Sachs was quite directly responsible for much of the run-up in the price of gasoline leading into the September 2008 market collapse), HERE and HERE.
So, if the CFTC's Gary Gensler telling you that it's common knowledge that Goldman was responsible for the runup in the price of gas in 2008 doesn't convince you, maybe this (see the Naked Capitalism post, below) will do the trick and compel you to contact your congressperson, your senator, or even the White House, directly, and tell 'em: "STOP WALL STREET'S CASINO BETS ON NAKED CREDIT DEFAULT SWAPS NOW!"
I'll leave you with what, IMHO, may be the most compelling reason of all to make that effort to contact your congresscritters, today...a post from Naked Capitalism's Yves Smith, from just over a week ago, reprinted in its entirety (with the permission of Ms. Smith)...
# # #
Crosspost from Naked Capitalism
So Why Hasn't the Credit Default Swaps Casino Been Shut Down?
Yves Smith
Naked Capitalism
Monday, March 1, 2010
Credit default swaps played a much more central role in the financial crisis than is widely understood, and they continue to get a free pass in financial reform proposals that they do not deserve. As we have discussed on this blog, and recount in more detail in the book ECONNED, central clearing and/or putting them on exchanges are inadequate remedies. Only a small subset of CDS contracts trade often enough for to be suitable for exchange trading. As for central clearing, the logic is that this would provide for consistent and sufficiently large margin to be posted (think of it as a reserve against the ultimate possible insurance payment required on the contract). But unlike real derivatives, CDS are subject to massive price moves ("jump to default') when a reference entity (the entity on which the CDS is written) defaults or goes into bankruptcy. That large price movement, means that the margin already posted will be insufficient, and there is no guarantee that the counterparty will be able to pony up the amount now due.
But perhaps more important, the idea that CDS have legitimate uses is questionable. They are used to hedge credit risk (sometimes) yet their pricing, per Bloomberg or any of the common commercial models, price CDS based on volatility, which is not based on any assessment of the underlying credit. So the idea that the pricing reflects default risk is spurious; indeed, CDS failed abysmally in predicting financial firm default risk during the crisis (Lehman was a particularly vivid illustration). But they serve to perpetuate the erosion of proper credit analysis (why bother if you can just lay off the risk?).
In the last two days, Gretchen Morgenson of the New York Times and Wolfgang Munchau of the Finacial Times have both launched salvos at CDS. Munchau's is even more vituperative than Morgenson's, which given the sober sensibilities of the Financial Times, suggests that opinion on the other side of the pond may be coalescing against the product.
Morgenson points out that even Ben Bernanke has started to question the legitimacy of CDS, but peculiarly is not as hard on his remark as she should have been:
"Using these instruments in a way that intentionally destabilizes a company or a country is -- is counterproductive, and I'm sure the S.E.C. will be looking into that."
Yves here. Huh? How, pray tell, is the SEC, of all regulators, going to look into CDS? CDS are specifically exempt from SEC regulation. If anyone has (or could decide it has) jurisdiction, it's the Office of the Comptroller of the Currency, and the Fed. So saying that swaps are a problem, and saying that someone who cannot possibly look into them will handle them, is just a fancy form of regulatory three card monte.
And if anyone had any doubts that the CDS market is officially backstopped, look no further than the Bear Stearns and AIG rescues. To put not too find a point on it, the industry understands full well who is the ultimate bagholder:
United States commercial banks, those with insured deposits, held $13 trillion in notional value of credit derivatives at the end of the third quarter last year, according to the Office of the Comptroller of the Currency. The biggest players in this world are JPMorgan Chase, Citibank, Bank of America and Goldman Sachs.
All of those firms fall squarely into the category of institutions that are too politically connected to fail. Because of the implicit taxpayer backing that accompanies such lofty status, derivatives become exceedingly dangerous, said Robert Arvanitis, chief executive of Risk Finance Advisors, a corporate advisory firm specializing in insurance.
"If companies were not implicitly backed by the taxpayers, then managements would get very reluctant to go out after that next billion of notional on swaps," he said. "They'd look over their shoulder and say, `This is getting dangerous.'"
Morgenson is positively tame compared to Munchau. I'm quoting him more liberally, because the tone of his remarks are remarkably pointed for him and the FT generally. Notice that he explicitly, and repeatedly, says the use of naked credit default swaps looks an awful lot like a crime:
I cannot understand why we are still allowing the trade in credit default swaps without ownership of the underlying securities. Especially in the eurozone, currently subject to a series of speculative attacks, a generalised ban on so-called naked CDSs should be a no-brainer.... Unfortunately, it is legal...
A naked CDS purchase means that you take out insurance on bonds without actually owning them. It is a purely speculative gamble. There is not one social or economic benefit. Even hardened speculators agree on this point. Especially because naked CDSs constitute a large part of all CDS transactions, the case for banning them is about as a strong as that for banning bank robberies.
Economically, CDSs are insurance for the simple reason that they insure the buyer against the default of an underlying security. A universally accepted aspect of insurance regulation is that you can only insure what you actually own. Insurance is not meant as a gamble, but an instrument to allow the buyer to reduce incalculable risks. Not even the most libertarian extremist would accept that you could take out insurance on your neighbour's house or the life of your boss.
Technically, CDS are not classified as insurance but as swaps, because they involve an exchange of cash flows. The CDS lobby makes much of those technical characteristics in its defence of the status quo. But this is misleading. Even a traditional insurance contract can be viewed as a swap, as it involves an exchange of cash flows. But nobody in their right mind would use the swap-like characteristics of an insurance contract as an excuse not to regulate the insurance industry. The fact that, unlike insurance, CDSs are tradeable contracts does not change the fundamental economic rationale...
Yves here. The "tradeable" aspect is exaggerated. While standardization of contracts has helped, most CDS are not traded; dealers lay off their risks by entering into offsetting swaps. Back to Munchau:
Another argument I have heard from a lobbyist is that naked CDSs allow investors to hedge more effectively. This is like saying that a bank robbery brings benefits to the robber. A further stated objection to a ban is that it would be difficult to police. There is no question that a ban of a complex product, such as a CDS, involves technical complexities that commentators like myself probably underestimate. It is conceivable, for example, that the industry might quickly find a legal way round such a ban. Then again, we would not consider legalising bank robberies on the grounds that it is difficult to catch the robber.
So why are we so cautious? From conversations with regulators and law-makers, I suspect they are not always familiar with those products, to put it kindly, and that they may be afraid of regulating something they do not understand. They understand, or think they do, what a hedge fund is. Restricting hedge funds is something they can sell to their electorates. Hedge funds were not at the centre of the crisis, but they are a politically expedient target. Banning products with ugly acronyms that nobody understands seems like unnecessarily hard work...
Yves here. Hedge funds and Wall Street prop desks replicating certain structured arb strategies that relied on CDS were far more important in the crisis than is widely understood. You'll be hearing more about that in due course. Back to Munchau:
But naked CDSs have played an important and direct role in destabilising the financial system. They still do. And banks, whose shareholders and employees have benefited from public rescue programmes, are now using CDSs to speculate against governments.
Where is the political response? The Germans want to bring it to the Group of 20, but they hesitate to do anything unilaterally. Christine Lagarde, the French finance minister, was recently quoted as saying: "What we are going to take away from this crisis is certainly a second look at the validity, solidity of sovereign [credit default swaps]."
A second look? I wonder what they saw when they looked the first time.
Yves here. The other defenses of CDS I've heard are equally dubious. One is they add to liquidity. Ahem, were corporate bond investors ever suffering from a lack of liquidity? That paper doesn't trade much because most investors are buy and hold. Even when I was a kid, in the early 1980s, when there was as much appetite for corporate bond trading as are likely ever to see due to high uncertainty over interest rates. Yet no one complained about illiquidity in the corporate bond market (as in yes, it may not have been that liquid, but no one felt inconvenienced, dealer spreads were not seen as problematic). And as CDS drain liquidity in crises. As bond yields rise, intermediaries and hedge funds, both of whom are leveraged and normally serve as liquidity providers, have to tie up of their scarce cash and collateral in posting margins on CDS positions. So they suck liquidity out of markets are precisely the worst possible moment.
The more we can to to contain this product the better, but I am afraid it will take another meltdown to teach us the lesson we should have learned from the last one.
# # #