Re: Credit Default Swap (CDS) - Lehman Final

[David Farber <dave () farber net>]

Begin forwarded message:

From: Charles Brown <cbrown () flyingcircuit com>
Date: October 23, 2008 5:07:45 PM EDT
To: Tobin Maginnis <ptm () pix cs olemiss edu>
Cc: Charles Brown <cbrown () flyingcircuit com>, David Farber <dave () farber net 
>
Subject: Re: [IP] Re: Credit Default Swap (CDS) - Lehman Final

Sure Toby, feel free.

One point I didn't flush-out was the role of the SIVs (Structured  
Investment Vehicles), which was where the banks parked their casino  
accounting.  Only when the accountants saw they were below market  
value (mark to market rules) and were substantially legal obligations  
of the banks, were the banks forced to unwind the SIVs.  The  
accountants were playing along too up until the size of the losses  
became apparent.  This helps to explain where these large banks'  
"losses" are coming from, i.e., the monetizing of the casino IOUs onto  
bank balance sheets at fair market value.  The SIVs were an attempt to  
prevent that from happening, just like Enron.  :)

Charlie


On Oct 23, 2008, at 1:58 PM, Tobin Maginnis wrote:

> Very nice! If you do not post on the http://www.rgemonitor.com/blog/roubini/ 
>  blog, I would like to share your metaphor with that audience.
>
> Regards,
> Tobin Maginnis
>
> ==========
> Charles Brown wrote:
> > Hi Toby,
> > Well done Toby, you are getting the idea.  Mr. David Reed has  
> > effectively dispelled the "brilliance" myth of the CDS market.  It  
> > is only "brilliant" in terms of its ability to fool people, all  
> > sorts of people.
> > I have taken the time to write the metaphor below which  
> > substantially, and accurately, describes the phenomenon.  Here  
> > goes.  Wally goes to Smallville and talks to the mayor about  
> > opening a casino in town.  The mayor thinks it is a fantastic  
> > idea.  Wally says there are a couple of preconditions though, he  
> > wants the casino to have special tax breaks for the players and no  
> > regulation or interference whatsoever in what goes on inside the  
> > casino.  Fair enough, they mayor goes along.  In fact, he and a lot  
> > of local businesspeople want to play too through player- 
> > representatives (hedge funds).  The mayor's friends are going to  
> > make a killing on the casino coming to town.  They want him to run  
> > for Governor next term.
> > The casino Wally is setting up is a little different from the  
> > traditional casino in that there is no "House" to cover the bets.   
> > The role of the traditional casino "House" is taken up by the other  
> > party to each bet made at any table (transaction) in the casino.   
> > The "House" (Wall Street) is providing the facility and the playing  
> > field for the players, who are mostly known to each other and the  
> > House anyway.  So, and this is crucial Toby, a bad or good bet at  
> > the crap table is covered by another player at the crap table, not  
> > the House.  Those are the rules.  The volume of action in the House  
> > is only limited by the number of IOUs other players are willing to  
> > accept.  The IOUs are payable in US dollars.
> > The players adore this game.  They walk in with $100 and can buy  
> > $5,000 worth of IOUs (chips), "nominally" issued by the House, but  
> > only as a custodian for the players;  like a private clearing  
> > house.  The chips are the IOUs (CDS contracts) while a player is  
> > involved in the game.  Winners and losers are made every minute by  
> > the action at the various tables, which differ only in the type of  
> > game (cards, dice, roulette, slot machine, etc.), not in the  
> > substance of an IOU exchanging hands for the right to play.
> > One day, one of the "high-rollers" at the casino has a few of his  
> > IOU's called-in by other players and whoa!  He doesn't have the  
> > money to cover his IOUs!  In fact, it turns out he has big losses  
> > already in the game!  He starts trying to collect on some IOUs he  
> > holds and finds that some of them aren't any good.  He was having  
> > so much fun playing the game and making so much money for himself  
> > and his staff on a current basis, in terms of fees and reporting  
> > profits to his friends and shareholders, that that there was no  
> > need to think about these details.  The casino had everything going  
> > for it, political cover, it's own bank creating money, albeit  
> > phantom money, private exchange, and a host of brilliant, credible  
> > players with deep pockets.
> > Now Wally has a problem.  Other players are lined-up outside his  
> > office wanting to collect on some of their IOUs.  Wally doesn't  
> > have the money, he's just the casino facilities operator he tells  
> > them.  "I"m just the clearing house taking a cut. You knew what you  
> > were doing when you gave and took those IOUs", he tells them.  But  
> > they shout, "You have the power and wherewithal to cover us!"  Some  
> > of us have more IOUs going the wrong way and didn't balance our IOU  
> > portfolios, and unpaid IOUs will only make the problem worse!  Your  
> > reputation is on the line and you are in this too Wally", they  
> > plead.  So, Wally goes to the mayor of Smallville and suggests that  
> > Smallville's citizens need to cover the bets made by the players at  
> > the casino.  After all, they benefited too, Wally argues.  Wally  
> > brought in lots of money to Smallville's town council and other  
> > politicians.  Funds flowed to Smallville and its environs and they  
> > also  put a lot of money into the mayor's upcoming run for  
> > Governor.  The mayor doesn't like it because he knows it is going  
> > to be hard to spin to the citizens of Smallville, but the  
> > alternatives as explained to him, are bleak indeed.  "What else can  
> > I do?" he mumbles to himself constantly.  The town's economy has  
> > become dependent on Wally's business.  The local economy will  
> > collapse since some of the local commercial banks are carrying some  
> > of the high-rollers IOUs.  The political pressure is enormous from  
> > Wally and his influential friends.  The mayor goes along again.   
> > "What else can I do?  File a law suit?  Against whom?  For what?",  
> > he tells his staff and neighbors.
> > Finally, an aide in the mayor's office exclaims, "Wait a minute!   
> > Why can't the casino patrons get together and cross-eliminate all  
> > these bets?  Net them out, gains against losses?  It's all IOUs  
> > anyway.  It doesn't matter how many times removed any particular  
> > IOU is from one another.  They are all holding IOUs transacted at  
> > the casino!  They put them all together in a big pot and compress  
> > them down to the nub, eliminating all of the debits and credits.   
> > The last players holding the IOU in excess of someone's else  
> > ability to pay take the netted-out loss.  That way, the largest  
> > players in the game that are still around take their losses.  How  
> > do we know they don't also have astronomical profits from the  
> > casino?  And even if they don't, what can they do, sue us to cover  
> > their losses?  We didn't know anything about their gains and  
> > losses.  If anyone is going to be sued they will sue each other  
> > over not paying their respective IOUs after compressing them to the  
> > nub.  Why should we and our citizens vouch for the action at the  
> > casino?"
> > Another said, "Even Wally had friends who weren't patrons of the  
> > casino, but most of his friends were regulars."
> > Then, another of the mayors aides said, "I get it.  They created a  
> > type of currency with these casino chips that were convertible into  
> > Smallville dollars."  Another said, "Now if only the City Council  
> > could understand, but they are only listening to Wally and his  
> > friends."
> > The citizens of this Republic need to understand this.  In fact, it  
> > is the duty of those of us who do understand it to explain it to  
> > them.  The substance of the above metaphor accurately reflects the  
> > details, regardless of Wall Street lawyers holding up 500-page CDS  
> > contracts.  That is Wall Street spin.  You see, Wall Street lawyers  
> > made a fortune in this market as well.  And Toby, in case you  
> > weren't informed, we are too stupid to understand what these  
> > brilliant people have "created."  Can you see that?  The  
> > "brilliant" people on Wall Street, the likes of Secty. Paulson, the  
> > progeny of numerous university business school professors, the main- 
> > stream press, et al, is just drivel.  Wall-street spin, or as David  
> > Reed would say, "failed physicists."
> > The remaining investment banks and other players want you and I to  
> > cover their IOUs and keep the casino in business.  If that isn't  
> > brazen enough, we don't even get a tax subsidy like they did on  
> > their profits, and still are getting!   The correct response of the  
> > mayor of Smallville is simple, if someone could inform him and he  
> > had any integrity.  Let the casino players unsort ("net out", or  
> > "compress") the pool of IOUs and sue each other over non-payment of  
> > their 500-page CDS contracts.  Their shareholders, hedge fund  
> > participants and other investors would take the compressed losses,  
> > however much it might turn out to be.  $1 trillion?  $2 trillion?  
> > $5 trillion?  The shareholders and investors of the regulated and  
> > non-regulated financial institutions around the world can absorb  
> > those numbers without burdening the already harassed citizens of  
> > Smallville.  If the citizens of Smallville understood that, maybe  
> > the mayor would change his mind since he is running for Governnor  
> > next year.  Maybe he would find the strength to do the right thing,  
> > to do his duty by his fellows.   The Smallville banks that  
> > participated at the casino have to be compressed as well, and some  
> > will fail.  That's unpopular in some circles of Smallville.   
> > Perhaps many will fail, so what?  Won't they likely fail anyway?   
> > Wasn't the value proposition that Wally came to Smallville with in  
> > the first place exactly that, i.e., the IOUs were an elegant, fool- 
> > proof way of "spreading the risk" on losses and of collecting on  
> > the IOUs?  Yes, that's exactly what the physicists, mathematicians  
> > and high-rollers that came with Wally to pitch the mayor had said.   
> > They said it over and over again as the casino was operating  
> > 24x7.   On the contrary, Wally, the mayor and all of their friends  
> > in the media frightened the citizens of Smallville into believing  
> > that they had  to incur further indebtedness and pledge what  
> > remains of their vanishing wealth to cover the outstanding IOUs at  
> > the casino.  No compression is necessary as long as a few of the  
> > high-rollers avoid scrutiny and prop-up the IOU market (Goldman  
> > Sachs, Morgan Stanley, certain purchased entities of other bankrupt  
> > high-rollers), because Wally and the mayor now have everyone  
> > convinced that the high-rollers bets need to be made whole, or they  
> > will suffer too, even worse.  They have been heard to say, "We are  
> > all in this together."  Yes, but only those who played at the  
> > casino, not those who did not.  And that Toby, is why this bailout  
> > and the management thereof is politically and commercially  
> > criminal.  Charlie
> > Begin forwarded message:
> > From: Tobin Maginnis <ptm () pix cs olemiss edu <mailto:ptm () pix cs olemiss edu 
> > >>
> > Date: October 22, 2008 9:51:44 PM EDT
> > To: dave () farber net <mailto:dave () farber net>
> > Subject: Re: [IP] Re: Credit Default Swap (CDS) - Lehman Final  
> > Results In
> > Dave,
> > It turns out that the settlement result is not clear. In her  
> > article: "Lehman CDS Payout On October 21: $360bn or $6bn?" Elisa  
> > Parisi-Capone argues that the primary "naked" CDS bag holder was  
> > AIG and that the total Government bailout of $120 billion for AIG  
> > was used to pay for the Lehman defaults. She goes on to say that  
> > "...among dealer banks and AIG the CDS fallout from Lehman’s  
> > default amounts to *around $200 billion* already."
> > In the comment section, a poster "M" spends a lot of time disputing  
> > this by arguing net liabilities are offset by counter CDSs meaning  
> > that investors trade positive and negative CDS which sum to zero  
> > resulting in no-one being at risk!?! Responses to "M" say that may  
> > be the case, but AIG did not have a balanced CDS portfolio leaving  
> > it "naked."
> > So only time will tell what the true losses are and how they will  
> > impact the already rapidly deteriorating financial scene.
> > http://www.rgemonitor.com/economonitor-monitor/254052/lehman_cds_payout_on_october_21_360bn_or_6bn
> > ==========================================
> > David Farber wrote:
> > > Begin forwarded message:
> > > *From: *Steve Rayson <steverayson () hotmail com <mailto:steverayson () hotmail com 
> > > >
> > <mailto:steverayson () hotmail com
> > > >>
> > > *Date: *October 22, 2008 5:58:32 PM EDT
> > > *To: *<dave () farber net <mailto:dave () farber net> <mailto:dave () farber net 
> > > >>
> > <mailto:dave () farber net%3E%3E>;
> > > *Subject: **RE: [IP] Credit Default Swap (CDS) - Lehman Final  
> > > Results In*
> > > http://dealbook.blogs.nytimes.com/2008/10/22/lehman-debt-swaps-settled-for-52-billion/
> > > Sellers of insurance on *Lehman Brothers* debt made net payments of
> > > $5.2 billion to settle an estimated $400 billion or more in credit
> > > default swaps, the *Depository Trust and Clearing* Corporation said
> > > Wednesday.
> > > As predicted, the net payments were a fraction of the $400  
> > > billion. Its interesting to me that despite the fact that the  
> > > Depository Trust and Clearing Corporation said this was going to  
> > > happen, there was still lots of fear last week that the number was  
> > > going to be in the 100's of billions.
> > > -Steve
> > > ------------------------------------------------------------------------
> > > Archives <https://www.listbox.com/member/archive/247/=now>
> > <https://www.listbox.com/member/archive/247/=now%3E>; <https://www.listbox.com/member/archive/rss/247/
> > > > [Powered by Listbox] <http://www.listbox.com> <http://www.listbox.com 
> > > >/>;
> > <http://www.listbox.com/member/archive/247>
> > ------------------------------------------------------------------------
> > ------------------------------------------------------------------------
> > <http://www.listbox.com/member/archive/247> ip <http://www.listbox.com/member/archive/247 
> > >10/23/08 2:48 AM dave () farber net <mailto:dave () farber net>





-------------------------------------------
Archives: https://www.listbox.com/member/archive/247/=now
RSS Feed: https://www.listbox.com/member/archive/rss/247/
Powered by Listbox: http://www.listbox.com