CDS Weapons of Mass Destruction
Market Ticker has a great post up today concerning CDS hedges which i had some questions about last night. Hat tip to Capitalist Preservation who has been all over the latest news all week like white on rice. Or white and brown in the case of rice pilaf. Or if its spanish yellow rice, then yellow..well you get the idea!
Excerpt of full article:
I buy a CDS on GE (a few weeks ago) for a couple hundred basis points ($200,000 per $10 million)
The SELLER of that CDS protects against possibly having to pay by shorting whatever he can against that short credit position. This means he buys PUTs, he shorts the common, he does whatever he needs to in order to lay off that risk. He does this because if GE goes bankrupt their stock would presumably go to zero; therefore, if he has a potential $10 million exposure on the CDS he will short $10 million face value of the common stock, or buy enough PUTs to pay him $10 million if the stock goes to zero.
The PUT writer (assuming he buys PUTs), being a market-maker, will in turn short the common to lay off the risk as well.
This hammers the stock price which then reflects into the pricing models for the CDS, driving them higher.
This cycle repeats; unfortunately credit rating models include market cap as one of their inputs, which causes a credit downgrade (eventually.)
That in turn adds more pressure.
This cycle is repeated until the company is destroyed.
Why is this not a problem with options and straight short sales?
Because with both straight short sales and PUT purchases the short side is required to post margin every night, and if the price goes the wrong way they get an immediate margin call and are required to buy that position back at a loss. That in turn puts pressure UPWARDS on share price and arrests the slide.
As such the people selling short (whether stock or listed options) do not dare short in unlimited amounts, because if they get caught on the wrong side of a squeeze they are dead.
The enforcement of risk against the people betting on a bankruptcy through regulated instruments puts a natural limit on their activity and prevents an unwarranted "death spiral".
But in the CDS world there is no mark-to-market margin supervision, because there is no central counterparty supervising exposure and demanding it.
As a consequence it is only the counterparty and the written document that can demand collateral posting and usually that is either on an infrequent schedule (monthly, quarterly, annually or on an "event") or in some cases not at all provided the writer maintains some specific credit rating criteria themselves!
Without nightly margin supervision on CDS short positions these vehicles have turned into the means to launch monstrous focused attacks on specific companies; the buyer has limited risk and virtually unlimited reward.
This is exactly like me buying fire insurance on your house, and in addition I can name the amount of insurance I want to buy, even exceeding the house's value!
So there it is. A huge amount of the AIG bailout and other banking rescues are being done to fund this stupid game played by traders the world over.
What this amounts to is an absolute raiding of the taxpayer by the banks. First they make insane profits while things go up, then they get bailed out at the bottom only to take all the profits when things turn around. Disgusting. Again, this is why I am stoutly anti-bailout. Let all these fools go bust and lose their jobs. The only systemic risk I see here is risking the very system that allows such games to be played.
You Can Pay As Much As You Want at Any Time
I often will stop by the site Angry Bear because the site amuses me. I love seeing what lefty, pinko, commies think about things economic as I find it both entertaining and revealing. There was a post today that stood out as particularly loathsome:
Median Family Income Tax About Zero
I have long thought that the nuclear option for the Democrats to crush the Republicans was to reform the tax code so most families pay negative income tax.
Now I learn that they have very nearly done that.
Via Ezra Klein STEPHEN OHLEMACHER reports for AP.
"WASHINGTON (AP) — A typical American family would get a tax cut under President Barack Obama's budget proposal, and their low-income neighbor would fare even better.
Their wealthier counterparts, however, would face some steep tax increases, starting in 2011.
Families making as much as $50,000 would owe no federal income taxes, as long as they have at least two children, according to an analysis by Deloitte Tax LLP.
A typical family of four making $50,000 a year would receive a payment of $40, according to the Deloitte analysis. A similar family making $35,000 a year would get a payment of $4,100, an increase of $1,200. Before the stimulus package was enacted, that same family would have owed $760 in federal income taxes.
The median household income was $50,233 in 2007, according to the Census Bureau."
Median family income was lower, since unmarried adults living together are one household but two families. However the typical voter is part of a family with less than four members. Still they are getting very close to a negative income tax paying majority.
The founders (and John Stuart Mill) were afraid of tyranny by such a majority. I think it is just what the country needs.(that should get some comments he mutters)
Usually I try to stay clean and keep things nice so as not to cause friction, but this little article is enough to get any free thinking person in a nasty state of mind.
Now understand that as a Libertarian I am all for the destruction of the Republican Party, especially the version of the last 8 years which were just democrats with an R next to their names. I never want the destruction of the republicans because then there would only be democrats, which is geometrically worse. Until there is a valid 3rd party (not in my lifetime) we must hope for total balance and gridlock. The only good government action is NO government action.
That said, get a load of this guy and his outright disdain for the founding principles of the nation. Also note the very essence of liberalism: crush the opposition, consolidate power amongst the masses, and then milk it for all its worth.
My only reply to such dumb lefty propaganda garbage is this:
Here in Massachusetts, the commie capital of the USA, home of Bostongrad and Kambridge, we have a choice to pay either the mandated state income tax rate, or a higher one if we so elect. Every year 99.95% of all respondents choose the LOWER RATE. If you cannot back up your "I want to pay higher taxes" bullsh$t with any real action, just shut the hell up.
And so this is my call to the lefty donkeys across the entire country. You can pay Uncle Sam (or Comrade Samolsky, whatever) as much as you want this tax season. The US treasury accepts all checks and will not seek you out to refund it unless you ask. Now I know for most liberals facts, figures, and basic math are difficult concepts, so I am going to spell this all out for you using small words and round numbers so you can follow along. Ready?:
-Get your W-2 from 2008 (if you actually worked)
-Find Line 1; this is your income for the year
-Multiply line 1 (line ONE) by 0.80 (zero point eight zero)
-Pay this amount in taxes by check or money order
-Remember to put a stamp on the envelope
Congratulations! You just did your nation a favor by paying 80% of your income in taxes. I am sure this will have a real effect this coming fiscal year!
If taxes are so great and liberals want to pay so much, go right ahead, nobody is stopping you. But alas that is the crux of the problem.
Liberals, socialists, and commies are all the same. They like to think they are so intelligent, nuanced, and thoughtful. If they were, they would not be so stupid.
And spare me the whole "capitalism and free markets brought us to this crisis, so they do not work" comments. The whole problem is that we have not had real capitalism or free markets since Mr. Alan Greenspan took over the FED and started messing with anything and everything he could get his hands on. That argument is a non starter. Take out ultra low interest rates, the LTCM bailout, and the current backstop sock hop and we will see how things really operate LEFT TO THEIR OWN DEVICES.
Sorry for the vent, but the sheer magnitude of ridiculous anti-constitution and anti-free market rhetoric out there right now is enough to make me puke.
Have a good night.