The EU arranged Greek bailout proceeds apace, as everyone else awaits for the official default date (Greece has already defaulted in my book, but I am in the minority). Hedged sovereign debt investors must feel like they are waiting for their wealthy grandfather to die so they can get to the reading of the will.

I have no dog in this fight, other than than an interest in seeing derivatives, especially Credit Default Swaps, appropriately regulated as insurance products.

But the process for determining a payout for CDS is fascinating. The people officially determining defaults are not objective Judges or impartial observers; rather, a group of self-appointed traders, conflicted, biased, non transparent participants — with positions affected by their own decision –  determine what a Greek default is and isn’t.

Who is on the ISDA committee?

Bank of America Merrill Lynch
Credit Suisse
Deutsche Bank AG
Goldman Sachs
JPMorgan Chase Bank, N.A.
Morgan Stanley
BNP Paribas
Societe Generale
Citadel Investment Group LLC
D.E. Shaw Group
BlueMountain Capital
Elliott Management Corporation

Again, I wonder loud: Why would one want to own something that has a payout determination made by this group of fucktards objective, ethical, unbiased committee members?

All of which raises a few issues in my mind: I do not know the answers to these questions, but they sure are intriguing:

1) Why would anyone ever buy a CDS? Do they have true intrinsic value, will they pay off like a futures contract or option? Or, must you pursue their payout via some combination of lobbying, litigation and persuasion?

2) If the answer to the prior question is “No to CDS,” then does this mean that sovereign debt cannot be hedged?

3) If that is the case, why would anyone buy any sovereign debt other than the very strongest nations? Outside of the US, China, Germany, and perhaps Switzerland, why would anyone purchase any other Sovereign debt? What do questions about hedging mean for debt issuance?

4) Which raises yet another question: If middling sovereign debt is downgraded by buyers, will these countries be forced to break out the printing presses? Might that add further pressure for the softening of the EU zone? the weaker countries be forced out of the EU zone?

5) Are we then going to see Drachmas, Lire and other forgotten currencies?

6) What does this mean for hyperinflation?

7) Lastly, what sort of a frenzy will the Gold Bugs be whipped up into?  Will they simply turn their enthusiasm into a yellow metal jihad? Are we going to see adverts in the WSJ and FT urging us to Buy Motherfucking Gold?

I do not know the answers to there queries, but they sure are fun to think about . . .

Category: Bailouts, Derivatives

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

35 Responses to “What Are Repercussions If CDS Hedging Fails?”

  1. farmera1 says:

    Greek debt ruling dangerous precedent: PIMCO’s Gross

    “(Reuters) – Bill Gross, co-chief investment officer at PIMCO, on Thursday took issue with a derivative panel’s decision that the restructuring of Greek debt does not trigger a payout on insurance protection, even after his firm backed the move.”

    Gross agrees with you, but apparently PIMCO doesn’t. Go figure.

  2. baychev says:

    CDS are bought because they are being sold to (un)sophisticated investors with no (skin in the game) downside risk, namely pension plans and hedge funds that attract primarily pension plans money.
    They were a good hyper-leveraged play on the credit bubble as well and hence were producing paper profits for some time for both seller and buyers.
    At present CDS have no value whatsoever for investors, neither as an asset, nor as a true hedge, but for banks they have genuine value due to the cash flows and the ability to game capital adequacy ratios.

    To your questions:
    1) If I were a bank, I would buy from another bank CDS to boost my capital adequacy ratio. As an investor I would never buy a CDS, it just does not make sense to hold it as a protection. As a trader I would buy it if I have confidence I can sell it at a profit.

    2) No debt could possibly be hedged by a 3rd party with weaker balance sheet, hence a bank levered 50 times cannot possibly leverage a sovereign even levered up to 3 times as Japan. That hold true only if the CDS is of material size relative to the capital of the seller.

    3) You buy debt because of the yield not because of the hedge, after a genuine hedge, you would most likely be left with no yield anyways. Most investors disregard the repayment of the principal as a legit risk when they are buying sovereign debt, hence they shall not even bother buying CDS for the purpose of hedging.

    4) Buyers do not downgrade debt, rating agencies do. Buyers buy when they have available cash and no better use for it. Demographics will exert ever more pressure on the Club Med countries.

    5) Color currencies are not solution to anything, weak economies do not borrow internationally in their own currencies but in other hard currencies. The Euro is a blessing for them given that they collect taxes in the same currency they are borrowing in.

    6) You cannot have hyperinflation without rising aggregate incomes at a rate above production, especially when over 50% of the population lives off government transfers either by being employed directly or by welfare programs.

    7) Raise the margin requirement to 10% and the gold price will go down almost in half, raise it to 50% and gold will become worthless, beacuse it has no utility value.

  3. dougc says:

    It will be cheaper to honor the Greek CDS than the long term cost of increased interest rates that soverigns will have to pay, the problem is that the committee that determines if a default occured are dominated by the banks that would have to pay . There will be another ruling after Greece adds CACs.
    Financial firms put their interest above the common good, who could of thought?

  4. mathman says:

    i disagree with the comment (though what the author said probably applied to him and many he knew): many are now finding that they didn’t need all the “toys” and gadgets that come from extravagent living, that they bought way too much stuff they didn’t need and now that they’re homeless they’ve given up the whole consumerist paradigm and finally realize that it was an ignorant way to live. Happiness and contentment can be had by living simply and simply living. Meals are much more appreciated when they aren’t guaranteed. One gives thanks every day for the small things one can do and make do with.

    Overpopulation combined with greed at the top has lead many people to make do with much less.

    (okay, now on topic):
    The banking sector and Wall Street is so screwed up that it’ll probably have to collapse before it’s brought back to some semblance of sanity. The misuse of the Black-Sholes formula and others (like the etched-in-stone idea that HOUSING PRICES NEVER FALL) have made a shambles out of the global banking system, housing, and the idea of debt-based money.


    “Anyone who has followed the crisis will understand that the real economy of businesses and commodities is being upstaged by complicated financial instruments known as derivatives. These are not money or goods. They are investments in investments, bets about bets. Derivatives created a booming global economy, but they also led to turbulent markets, the credit crunch, the near collapse of the banking system and the economic slump. And it was the Black-Scholes equation that opened up the world of derivatives.

    The equation itself wasn’t the real problem. It was useful, it was precise, and its limitations were clearly stated. It provided an industry-standard method to assess the likely value of a financial derivative. So derivatives could be traded before they matured. The formula was fine if you used it sensibly and abandoned it when market conditions weren’t appropriate. The trouble was its potential for abuse. It allowed derivatives to become commodities that could be traded in their own right. The financial sector called it the Midas Formula and saw it as a recipe for making everything turn to gold. But the markets forgot how the story of King Midas ended.”

  5. MayorQuimby says:

    Barry the bear is so much cooler than Barry the bull.

    Just sayin’…

  6. DeDude says:

    I would rather do business with that African Princess who emailed me last night than with “this group of objective, ethical, unbiased committee members”. Allowing them to run their own unregulated insurance companies and then to redefine the word default to avoid a “covered event” is another robbing of hard working Americans by the Wall Street banksters.

  7. given..

    I never understood why there wasn’t an ‘Options Exchange’ for “Listed Bonds” .. (like there is for, many, “Listed Equities”)



    It’s a large ‘Market’, big enough to be, both ‘Bear’, and, ‘Bull’, at the same may care to ‘give it a Shot’ ..~

  8. WOT:


    where did this Lie..6) You cannot have hyperinflation without rising aggregate incomes at a rate above production, especially when over 50% of the population lives off government transfers either by being employed directly or by welfare programs.


    or, differently, Can anyone, actually, Prove that as ‘being the Case’?

    Argentina, Brazil, Rwanda, Zimbabwe, (All, at the minimum) seem to be Examples that put that, supposed, ‘Fact’, in serious Question..

  9. biscuits says:

    Good job with your reporting on this. I’m seeing links and quotes from Barry Ritholtz everywhere.

  10. MayorQuimby says:

    All of these scams, lies, coverups and bs are setting the stage for the mother of all collapses. It will come from nowhere. There will be no bounce.

    Faith in the system itself is being destroyed. I can easily see everything going to shit within a month….bonds, stocks, CDs, everything.

    It is going to happen because nothing has been fixed, excessive credit is getting more excessive, perpetrators of fraud are emboldened, gvmt is complicit, debts and deficits both nationally and per capita are increasing quickly….it is a THIRD WORLD SITUATION and 3rd world economies go haywire all at once.

    I for one cannot wait even though it will mean almost guaranteed unemployment for myself and 95 percent of my friends. So be it. It needs to happen. Things arae completely out of control.

    And when it does happen I’m hoping all laws for the past two decades are automatically repealed along with the suspension of the statute of limitations for financial fraud and crime. Then…banksters behind bars.

  11. constantnormal says:

    @BR “… they sure are fun to think about . . .”

    … you have a strange definition of “fun” …

    I confess to not being able to wrap my mind around the potential scope of the calamity … I see a mass of CDS, in notional value rumored to be somewhere well in excess of ten times the planetary GDP, all interlinked in an unknown and chaotic manner, with sound and solvent financial institutions mixed in amongst the vaporous and insolvent … and this web of toxic pending disaster is wrapped around the planet, connected by parallel network of electronically-linked exchanges and much smaller pools of other forms of assets (bonds, stocks, commodities, property…) … and a bunch of ignorant, clueless fools playing jenga with it all …

    Who will pull the wrong block? And when?

    And when (not it) the chaotic collapse begins, what could possibly stop it without also stopping the global economic machinery?

    I have spent a lotta time pondering the “what-to-do-if” line of thought, and have concluded that there is nothing I can do that will make any significant difference, I can only wait …

  12. rd says:

    It is going to be interesting to see how CDS’s play out. It may be the final leg of the accounting rule fueled financial crisis.

    The various Basels and other accounting rules have given undue weight to bond ratings by a select few firms, the ability of a small group of parties to bet among themselves and use those bets (CDS’s) to make risk magically vanish, do overnight “repo” loans to make liabilities disappear, and transfer money to subsidiaries aborad to vaporize customers’ money (apparently countries with extradition treaties for criminals don’t have extradition for illegal wire transfers).

    As a result, much of this ifnancial crisis has been purely artificial where the rules themselves made gaming the system for the benefit of the few at the expense of the many legal and apparently desireable based on the unwillingness of policy makers to make any signficiant changes. I wouldn’t mind except that the same parties then expect that the taxpayers to step in when the small group of players blow themselves up to make them whole. Somehow, we need to make it just as acceptable for them to go bankrupt.

  13. louiswi says:

    If individuals are going to be forced into owning gold, there needs to be a discussion on how gold would be properly held. Consider: rightfully, about 3 ounces of lead need to be held for every ounce of gold. Even before the purchase of the first ounce of gold, one will need to acquire a “lead administrator” such as a Baretta Extrema 2, or an equal product from Browning or Mossberg. For every 10 ounces of gold acquired, one will need to add an additional administrator and at some point a competent staff member will have to be added. Significant amounts of gold acquired will result in significant overhead to protect it. Not as easy as it sounds for sure. There must be a better way, don’t you suppose?

  14. Robert M says:

    Dealbook put this out late yesterday afternoon. I am posting because I know you like graphic information
    Breaking up is hard to do
    Please take it down if you can post it elsewhere.

  15. MayorQuimby says:

    Louis…gold is crap. If it comes back to back money, it will fail quickly. Fiat backed by collateral ie money supply matches economic GDP is the best way to go. Go read denning ears one dollar of capital.

  16. MayorQuimby says:

    Louis…gold is crap. If it comes back to back money, it will fail quickly. Fiat backed by collateral ie money supply matches economic GDP is the best way to go. Go read denningers one dollar of capital.

  17. constantnormal says:

    I suppose someone should take a whack at answering your list of rhetorical questions …

    1) Why would anyone ever buy a CDS?

    A) the same reason anyone purchases snake oil of any sort … they were sold on the dubious premise that these represented a form of insurance against loss. “Hedging” is a magical term in a lot of the investing community.

    2) does this mean that sovereign debt cannot be hedged?

    A) Sovereign debt may be able to be hedged, but not by anything other than an unrelated asset possessing an adequate margin of safety. A bundle of oppositely-oriented CDS’s does not qualify. One cannot use a vaporous promise to hedge against another vaporous promise.

    3) … why would anyone buy any sovereign debt other than the very strongest nations?

    A) There are some reasons, usually having to do with domain-related restrictions on the purchase of sovereign debt. E.g., a nation might make it illegal for their citizens/corporations/institutions to buy foreign sovereign debt, or they could require that collateral for debts incurred in their jurisdiction be held in the local currency or bonds. But the answer to that question is that the bulk of sovereign debt traffic would occur only in the financially strongest sovereigns. Isn’t that what occurs in the Real World? Are Russia or Mexico (or Greece) really able to float a lotta debt?

    4) … will these countries be forced to break out the printing presses?

    A) I think so … stay tuned.

    5) Are we then going to see Drachmas, Lire and other forgotten currencies?

    A) I consulted my Magic 8-ball, and it replied, “Without a Doubt”.

    6) What does this mean for hyperinflation?

    A) I suppose that those nations that will be printing large amounts of currency to devalue their debt, might see some significant inflation … assuming that they can out-print every other nation on the planet, who are likely to also be running their monetary printing presses at warp speed. If everyone is printing money at a more-or-less equal rate (i.e., as fast as they can), it strikes me that there will be no import-induced inflation, and that wages might be able to keep up with prices in such a situation. Maybe. It all sounds like something an idiotic central bankster might say, so take it with a grain of salt.

    7) what sort of a frenzy will the Gold Bugs be whipped up into?

    A) … the gold bugs are always in some sort of a frenzy. It’s one of the fundamental constants of the universe.

  18. quantacide says:

    Barry, seriously, you have a great site and my favorite out there (I think it’s because you include cars). But its being besmirched by a continual unsophisticated diatribe on CDS.

    First, there is $3B in Greek CDS outstanding vs. about $400B of Greek debt. Second, the ISDA Determinations Committee (“DC”) has customers that need to settle trades — while it is easy to denigrate the members of the DC , their customers call the shots, and given that CDS is a zero-sum game, you have players on both sides.

    While the process is not perfect, there are checks and balances. This first step in the Greek restructuring drama was precisely NOT a credit event nor was it a restructuring event.

    This is a DC ruling on the ECB getting a better deal than the PSI.

    We are still waiting for the CAC, and even then, it could still NOT be a restructuring event if it is not coercive. This is objective, by the rules. The inflamatory and ill-informed posts really bring the quality of your site down.

  19. ssc says:

    Beychev says:
    7)Raise the margin requirement to 10% and the gold price will go down almost in half, raise it to 50% and gold will become worthless, beacuse it has no utility value”

    “anti gold bugs” (Buffett, et al) are as bad as gold bugs. The “no utility value” statement is 100% false, as gold has been used in circuit boards, audio equipments just about forever. At $1700 plus a troy oz, it has no utility value, at $1.7 a troy ounce, it has plenty. It’s not the metal that has no utility , it’s the price. No matter what the “margin requirement” is, unlike paper currency, gold will never ever be worth nothing.

    All that said, other than some tiny amount of family jewelry, I have no gold, physical or otherwise, once in a while, I trade some paper gold. I do not trust paper currency, but as an exchange medium, I trust in my ability to manage it.

  20. b_thunder says:

    Why would anyone ever buy a CDS? – For the same reason they still buy/trade MF Global common!
    Hoping to sell to a greater fool. But that’s for the “small players.”
    The “big players” aka the 15 banks that run ISDA Committee – for them this is just a scam to get around various capital requirements.

  21. jib10 says:

    Here is my shot at the questions:

    1) You buy CDS because they are a fig leaf that allows you to lever up much more than you should be allowed to. Your actual protection is ‘ lobbying, litigation and persuasion’. Your too big to fail so you wont fail. And if you do, who cares, it aint your money (but the bonuses paid out from your highly levered play are).

    2) No it cant be hedged.

    3) Since CDS are a fig leaf, does it matter that the fig leaf is removed? As long as banks can not fail, and losses from sovereign debt are born only by govts, not by banks, then its party on. As soon as some one big goes under because of sovereign debt, then it will back to the future, the old pre-CDS way. which means the amount of debt that people are willing to provide to most sovereigns will be much lower in aggregate than they are providing today. Since the govts borrowing heavily today do not want that to happen, they will do all they can to prevent it a bank from taking losses from sovereign debt.

    4) This is where the party could end. Since the big guys (US, China, Germany) need to print to keep the game going, how much money printing will the big guys be willing to do to keep the small guys afloat? The big guys will be able to borrow with or with out CDS or TBTF. At some point they can stop printing and cut the little guys loose. I dont know what the level is that cause the big guys to cut the little ones loose but I would not bet it is rational. Politics, voter emotion may dteremine the limit before economics does.

    5) When the big guys stop printing, yes.

    6) Yes in the small guys but not in the US, Germany, or China. Having all the hard currency leave your country to pay off your debt and trying to replace it with your own worthless currency to keep your economy liquid is exactly how all modern hyperinflation happens, from Germany to Argentina to Zimbabwe.

    7) Gold bugs, I dont know. Forget it Barry, its just GoldBugTown.

  22. VennData says:

    Well, well… the “Gold bugs” and other assorted right-wing, GOP genuflectors are UPSET by “self-regulation?”

  23. rktbrkr says:

    I wouldn’t expect that group of fucktards to agree that anything that might cost them significant money has occurred. Any higher authority that can regulate them or coerce them into honoring their contractual commitments is too afraid of the consequences of forcing them to pay that they remain silent, they don’t want to see the Emperor naked.

    Meanwhile those of a higher authority, the soverign and super-soverign types (ECB etc) are busy cutting deals with Greece to get a pass on the bloodletting. As this drama plays out behind closed doors the haircut % creeps ever higher making the “no credit event” ruling more preposterous. In the end the private investors will be haircut down to their bare, bloody crania and the rates paid on future debt financing by the PIIGS and others will head up which will cause the super soveigns to step in and buy trying to lure private investors into another trap. If that doesn’t work then all hell breaks loose. Of course all hell could break loose sooner if any of the PIIGS force their elected governments by vote, riot or referendum to repudiate the “deals” the Euro banksters have foisted on them.

  24. carleric says:

    Yes, why would anybody with a functioning brain buy a CDS? Could it be that they are sure our government will pay them off with taxpayer funds? I found the critical comment about gold pretty funny….let me ask you this, in the past ten years who did better? Gold investors, stock investors or those who hold dollars? Just wondering….rotflmao…

  25. gremlin says:

    I think the buy gold advert will have to end in the word “bitches”

  26. baychev says:


    The margin requirement is presently about 6.5%, it was raised by a ‘whopping’ 1% and that plunged the price of an ounce from 1,900 down to 1,600 in less than a week. Hopefully that gives you an idea what a bubble gold is in and where not-CDS-like margin requirements could send it.
    I concur gold’s utility is not quite zero, it is mainly used for jewerly in Asia and tiny amounts go into electronics, but the latter use is diminished by the day due to technological advances. My point is that gold will never buy you anything, take it to the store and try to transact in it, it won’t work out for you unless you go to a pawn shop and take a 30% haircut.

  27. wpg says:

    > 2) … does this mean that sovereign debt cannot be hedged?
    > 3) If that is the case, why would anyone buy any sovereign debt other than the very strongest nations?

    I truly don’t understand the underlying premise of question 3. Isn’t the answer generally “because you believe the interest rate/expected return is high enough to compensate you for the risk?” – basically the same reason any investor invests in a more risky asset other than cash? If I buy AAPL say, the question of whether or not doesn’t usually t come up: I just don’t buy AAPL if I then immediately want to hedge my exposure.

    I truly don’t understand why investors want to be able to buy an asset and then hedge away both the risk and the excess return. CDS’s are (esp. in the corporate CDS world) not too bad at this; you end up with a largely risk free asset which (after CDS premiums) give a net return comparable to risk free assets. So why bother buying it in the first place? Now I do understand there are various regulatory regimes that in some case preference certain parties (often banks) to actually holding specific sovereign debt regardless of returns (and so there is an incentive to hedge – you are holding the bonds not to make excess money but because the law makes it advantageous). But from the real _investor_ perspective, be it an individual through to a hedge fund, why should it matter if something is hedge-able? If I don’t what that risk and that return, don’t buy it.

  28. biscuits says:

    I think its spelled “bitchez” , if I get your drift.

    “I think the buy gold advert will have to end in the word “bitches””

  29. biscuits says:

    Regarding gold’s utility, there has been talk in the past of China adopting a gold standard. If they did, that would trump any “utility” value, I think.

  30. Marshall says:

    I would be upset too, but CDSs are the dumbest form of social pollution known to mankind (short of nukes) and Greece and the ISDA have done more to eliminate their use than anything the supine regulators and corrupt legislators would have done.

    Gross represents the shriek of the rentiers.

  31. No kidding…which is why one shouldn’t accept ISDA “standard” language.

    Again, this isn’t the first time we’ve seen problems with sovereign debt default, and “voluntary” restructuring. There’s always some new wrinkle with ISDA docs. Most investors weren’t paying attention.

    As you say, it’s like an insurance policy, and one should negotiate the protection one wants without the exclusions and riders. Some claim it will make the bespoke CDS less liquid, but it actually makes it more valuable and liquid, since it’s a better deal (although it may initially appear more expensive).

    It’s true that CDSs have provided hedge value if one bought them when they were cheap (a couple of years ago) and everyone was touting Greek bonds. But most of this is fodder for speculators looking for the large move in the premium to reverse the trade. Then when one tries to get out of the trade, you have to expect a large bid/ask and then you get gouged as the bid side moves the minute you as for a bid. I know someone very well who put on a $10 million notional position in Greek CDS. He had a huge gain and when he asked for a bid, the price moved so that he was taking a $500K hit (still with a huge profit in the trade). He found all the other dealers moved immediately too. It’s as if they have each other on speed dial ( or screen dial).

  32. baychev says:


    Global gold production is 2500 tonnes and that equals to 151bn at today’s prices, annual net credit issuance in China is 10 times that amount. Do you take that statement even remotely seriously?

  33. Francois says:

    Janet Takavoli on the possibles swindles with CDS. It’s not pretty!

  34. Orange14 says:

    Given the experience of Lehman and AIG, isn’t the correct question to ask, “why on this earth would anyone be the counterparty to insure the Greek debt from default?” Correct that such products are really insurance contracts but what is the risk adjusted premium? I know what my premium is for car and homeowners insurance and pretty much could figure out how such premiums are calculated. Given all the issues with sovereign debt, I have no clue what the proper premium would be and I certainly would not insure anything that is not owned by the party requesting the insurance (such as what was done in the lead up to the 2008 collapse.

  35. victor says:

    I wonder what Ajit Jain’s take would be about all this now that Buffett confessed that he too dabbled and lost some $10b, in his own words “dumb mistakes” that probably included CDS’?