Reply to: CDS insurance

[Freamon]

Bankers pay should be fixed. They should be on a fixed salary with no variable bonus element at all. If they screw up, they should be sacked without any golden parachute. That way, even if their salary is high, at least they would not have a big-bonus incentive to take reckless gambles, because their pay would be the same regardless of good performance or super good (& probably short term) performance. And they would know that they had to make a reasonable effort or else they'd be sacked.

I'm sure there are some disadvantages to this approach. Have you thought about them?

[Jeff Maginty]

..

[AtW]

Absolutely, in fact they have a fiduciary duty to do so. Doesn't mean they'll win though, the banks are still king of the hill and have more expensive lawyers.

That's rare case when I wish them to win.

[Freamon]

And a good article here The euro zone crisis: When is a default not a default? | The Economist

The people who decide on these things are the members of a determinations committee comprising ten bankers and five investors. In theory, that might suggest the investors could get overruled. In practice, any decision not backed by 12 members would go to an independent review committee. Since this decision was unanimous, it seems as if the rules were unambiguous; the Greek deal is not a credit event.

The "investors" also know what's good for them. If the banks go under, everybody loses.

[Freamon]

What about hedge funds who bought cut price Greek bonds with CDS to hedge against loss, surely plenty of lawsuits should happen.

Absolutely, in fact they have a fiduciary duty to do so. Doesn't mean they'll win though, the banks are still king of the hill and have more expensive lawyers.

Sounds like this whole CDS tulip is no better than PPI, in fact very much like it - in case of voluntary redundancy it also did not pay out as well as in many other cases. But surely not every Greek debt holder agreed to swap debt, surely those who did not and got forced to do so can claim CDS default event?

Contracts are made to be broken, all the participants care about is who pays.

[AtW]

Sounds like this whole CDS tulip is no better than PPI, in fact very much like it - in case of voluntary redundancy it also did not pay out as well as in many other cases. But surely not every Greek debt holder agreed to swap debt, surely those who did not and got forced to do so can claim CDS default event?

[BrilloPad]

And a good article here The euro zone crisis: When is a default not a default? | The Economist

The people who decide on these things are the members of a determinations committee comprising ten bankers and five investors. In theory, that might suggest the investors could get overruled. In practice, any decision not backed by 12 members would go to an independent review committee. Since this decision was unanimous, it seems as if the rules were unambiguous; the Greek deal is not a credit event.

[BrilloPad]

What about hedge funds who bought cut price Greek bonds with CDS to hedge against loss, surely plenty of lawsuits should happen.

Good point. Also, I was wondering about banks who have bought CDSs and so might have a short term vested interest in seeing them payout? I appreciate the point Freamon is making that if Greek CDSs pay out it will triiger a train of events which will see most banks suffer alot.

[AtW]

They are an industry body made up of a panel of representatives of various banks. This means they will obviously do what is most advantageous to the banks, i.e. even if Greece does default they will avoid categorising it as an event of default for the CDS.

What about hedge funds who bought cut price Greek bonds with CDS to hedge against loss, surely plenty of lawsuits should happen.

[Freamon]

Not until today, why?

They are an industry body made up of a panel of representatives of various banks. This means they will obviously do what is most advantageous to the banks, i.e. even if Greece does default they will avoid categorising it as an event of default for the CDS.

You really should read the article I posted:

What the Greek Debt Crisis is Really About

Long into the European night, the talks to save Greece continue. In today's Daily Reckoning, we'll do something we can barely stand to do: we're going to write one more time about Greece. If you can stand to read it, you may come to the same conclusion we reached.

That conclusion is simple: what's going on in Europe has nothing to do with solving the Greek debt crisis and everything to do with preserving a corrupt system based on limitless debt and growing government power. The sooner you understand that the sooner you'll be able to prepare for what happens next. There are two options for what happens next, and we'll get to those shortly.

First, though, doesn't it strike you as strange that all of Europe can be brought to its knees by tiny little Greece? Greek GDP is just 2.4% of Europe's GDP. In economic terms, Greece doesn't matter. Its lack of growth or economic competitiveness shouldn't be factors that can destroy Europe's 13-year single currency experiment.

Yet Greece obviously does matter, or else markets wouldn't be anxiously waiting for tonight's announcement of a second bailout totalling €130 billion. The correct question, then, is why does Greece still matter? If you rule out the obvious things that don't matter, that leaves everything else. Or as Sherlock Holmes was fond of saying, "when you have eliminated the impossible, whatever remains, however improbable, must be the truth."

First, let's see why the possible explanations for Greece's importance to the world are actually impossible. Take the issue of debt reduction. As we wrote last week, the deal before Europe would reduce Greek debt to 120% of GDP by 2020. The IMF says that level is sustainable.

Back in a universe where common sense prevails, you can see that the plan is a joke, at least in terms of debt reduction. A plan to reduce Greek's debt to 120% of GDP...EIGHT YEARS FROM NOW...is not a serious plan about debt. Therefore the plan cannot be about debt reduction.

Will the plan make Greece more competitive in the long run? Well, probably not. In order to get more money by March 20th, the Greek Parliament had to agree to certain structural reforms. Some of those reforms might even be a good idea. But cutting the minimum wage isn't going to be popular. And with Greek GDP shrinking by 7% in the fourth quarter, years of austerity won't make Greece more competitive. The lifestyle of the Greeks will be destroyed and the debt will remain. Therefore the plan cannot be about making Greece more competitive.

Does saving Greece save the euro? Not at all. The euro would be better off without Greece and Greece would be better off without the euro. The Germans are even planning for a euro that doesn't include Greece. With its own currency, Greece could default, devalue, inflate and start over. Argentina did it in the last 10 years. It's not rocket science. Saving Greece is not about saving the euro.

If saving Greece is not about saving the euro, and if it's not about reducing Greek debt, and if it's not about making Greece a more competitive economy...then just what IS it about? Well, now that we've rule out what's impossible, let's look at what's left.

Saving Greece means preventing a technical default. But why is that so important to the European Central Bank (ECB) and the International Monetary Fund (IMF)? The current plan certainly looks like a default. Under the plan, €100 billion worth of Greek debt would disappear thanks to a debt swap agreement with private sector investors. The ECB has twisted enough arms to get creditors to accept a 70% haircut on their current Greek debt without actually calling it a default.

The final details of the agreement between private sector investors and the EU were supposed to be released before today's meeting. But they haven't been yet. This is one of those glitches that could still derail the whole agreement. For example, creditors could take legal action for being forced to accept losses without recourse to credit default insurance purchased in the event of a default.

It gets kind of wonky here. But really, it's about who is making the rules in Europe and whether a name actually means anything. To you and me and everyone else in the universe where common sense prevails, a non-voluntary 70% loss on your government bonds is a default. If you loaned someone $1,000 and they paid you back $300 and asked you to be grateful, you probably wouldn't be.

But you and I don't get to decide what constitutes a credit default. That honour belongs to the International Swaps Derivatives Association (ISDA). The important thing to keep in mind here is that the ISDA is a trade group made up of banks and financial firms. Those are the firms that have the most to lose if Greek bonds default. It's in the interest of the members of the ISDA that a non-voluntary credit event in Greece NOT be called a default.

It gets even murkier here. The ISDA essentially represents the global banking system. In Europe, the banking system is full of government bonds. Those bonds are nominally assets. If Greece defaults, it sets a precedent for how other countries might deal with unsustainable debt levels. This imperils the collateral of Europe's entire banking system.

If you want to put it in simpler terms, let's say that Europe's banking system is full of rotting meat. Some investors bought that meat thinking they were going to get prime rib. But they can smell the stink of the meat from a mile away. They want to be compensated for the bad meat. The ISDA, which owns the freezer in which the meat went bad, says, "Well, we've decided the meat isn't bad after all. And you have less of it than you thought anyway, as of now."

This is a crude analogy. But you can see the basic problem: everyone else knows that if Greece defaults, the value of other government bonds in Spain and Italy and Portugal will plummet too. A Greek default wouldn't be important because of the size of the default (although French and German banks would stand to lose a fair bit). It would be important because it would begin the process of blowing up bank balance sheets all over Europe.

When you realise that the ISDA and the ECB and the EU are in league to save their financial skins, you realise that the Greek rescue plans is about preventing other countries from realising that default is an option. In fact, it's not even about preventing the realisation. It's about making it impossible for a country to default on its obligations...even if it means selling the population into servitude for years to come.

If the centralised European Welfare State model is to survive, banks must not take losses on their government bond holdings. Individual and private investors, on the other hand, will be forced to take losses through a "collective action clause". This clause allows your securities to be revalued without your consent if a majority of other bondholders agree to it.

Now we're coming to the real nuts and bolts of what's at stake. The technocrats in Europe are at war with private investors. The members of the ISDA are in league with the technocrats to preserve their system. That part is easy to understand.

The technocrats are employed by government and get to spend your money. This system is good for them. It's good for the members of the ISDA too. Loaning money to the government is good business. Collecting rent off the expansion of credit is easy money. They want the system to last as well.

Who is the system not good for? Everybody else who's on the outside looking in. Investors who want their capital to be productive are out of luck. And taxpayers who question the value of austerity measures and debt reduction plans that don't really reduce debt are also out of luck. No wonder they are angry.

We've come a long way, then. Greece isn't about saving Greece. The only reason something so small and insignificant can matter so much is that it matters in a way no one is willing to say. It's about the subversion of sovereignty and democratic processes by removing decisions from people and giving them to trans-national financial elites. It's about preserving a global system that's based on the accumulation of debt and growing government power because there are two groups of people who benefit tremendously from that system, even if most people don't.

Maybe we're reading too much into what's going on in Europe. It could be all about vanity. Europe's policy makers believe they can move Heaven and Earth and make even the most unworkable economic model work. They refuse to chuck their theory aside in the face of reality. They've spit the dummy.

Or maybe this really is a struggle over the power and influence of the financial sector and the government in our lives. Hmm. What do you reckon? Who's going to win? Send us your thoughts to [email protected]

Regards,

Dan Denning
for The Daily Reckoning Australia

[BrilloPad]

You do know who the ISDA are, right?

No - I had to look it up.

They have said that a default has not yet occurred, because Greece has not yet failed to make a bond payment - only passed a law which indicates what they will do. Stating your intention does not place you in default - following through on that intention does.

It's a bit like writing a letter to your bank saying that you only intend to pay 30% of your next mortgage payment. You are not in default until your payment actually bounces.


So it buys everyone a couple of weeks to trawl through the small print and find some other clause to prevent a default from being declared.

I found a good article here Gross Says ISDA Yet to Make Final Call on Greek Default-Swaps - Bloomberg

"the group will probably make one more decision on the issue."

"A swaps payout may still happen if Greece uses collective action clauses on private investors who refuse to take losses on their debt holdings, according to ISDA’s rules."

It does seem odd to me that those in the market seem to make up ISDA. Isn't there the possibility of market manipulation?

[centurian]

They have said that a default has not yet occurred, because Greece has not yet failed to make a bond payment - only passed a law which indicates what they will do. Stating your intention does not place you in default - following through on that intention does.

It's a bit like writing a letter to your bank saying that you only intend to pay 30% of your next mortgage payment. You are not in default until your payment actually bounces.


So it buys everyone a couple of weeks to trawl through the small print and find some other clause to prevent a default from being declared.

[AtW]

You do know who the ISDA are, right?

Not until today, why?

[Freamon]

So now "insurers" say Greek's stuff (whatever it is) did not constitute default so no payout will be made

"The International Swaps and Derivatives Association (ISDA) has ruled that a "credit event" has not occured for Greece. "

Debt crisis and EU summit: live - Telegraph

Should not even be legal to have such insurance.

You do know who the ISDA are, right?

[AtW]

IIRC the amount of haircut was chosen carefully to avoid it being a default.

It's not a default because majority agreement was forced out of lenders. At least that's the line insurer lawyers will probably stick to ...