New York City CDS Back To All Time Wides

thank you

Putting this back to the top in the hopes people who might have missed it have a chance to read & opine. When it looked like NYC was going broke in the '70's (I think it was the 70's. I know I was alive but much much younger) real estate was - in some case - literally being given away. Much talk of NYC defaulting on its debt will spook this market further I believe.

NYC will not default because Uncle Sam will not allow AIG to default. The global implications are far too wide. AIG's implosion would trigger an economic apocalypse. Read all about AIG and why they are too big to fail:

http://www.dailywealth.com/archive/2008/oct/2008_oct_04.asp#

A little snippet if you are too lazy to read the link: "without the government's actions, the collapse of AIG could have caused every major bank in the world to fail."

Otto: "NYC will not default because U.S. will not allow AIG to default" ???

An AIG default would bring financial Armageddon as every bank and insurance company has AIG CDS exposure. Its not an option unless you want all the banks and insurance companies to go under.

NYC, on the other hand, is only a Muni held extensively by unlevered rich retail investors. Makes no difference to the U.S. financial system if NYC bonds pay 20 cents on the dollar or 90 cents on the dollar. The rich people who hold NYC bonds will be -- less rich.

I don't expect an NYC bailout. I do expect fiscally responsible Bloomberg to cut spending and increase taxes just sufficiently to pay down existing debt.

cds?

cds?...

CDSs are Credit Default Swaps. They were created as a way to hedge credit exposure. Say you own Johnson & Johnson debt, and you want to hedge against the possibility of default. You enter into a CDS with a counterparty, paying them a certain agreed upon number of basis points per million of bonds protected. So in the case of J&J, which has very little likelihood of default you might pay 50 basis points to insure your position. So for $5,000 I could insure a possible loss of $1,000,000. If you own GM bonds the premium would be astronomical, if you could even find a counterparty to enter into a contract, because of the high likelihood of bankruptcy.

As aside, before the US became mired in the current credit risk, CDSs for the US were 6 basis points. Now, with all the increased debt the US has taken on, the CDS rate is over 100 basis points.

Now the CDS market was started to hedge credit exposure, but being unregulated, it soon became a market filled with financial "betting." In other words, folks bought and sold contracts among themselves based on whether they thought XWZ company would default or not, without ever owning the underlying bonds.

The CDS market went from zero to something like 50 trillion dollars (in a matter of a few short years) as people bet for/against debt they did not own. For example, a company could have outstanding debt of $5 billion, let's say, and CDS contracts of 10, 20 50 times that amount.

One of the major problems/exposures that caused the government to backstop AIG was all the CDS risk they had taken on (which they did for the fee income looking at CDSs as a form of writing insurance, something they thought they understood... wrong). You may also remember when LEH went belly-up the world held its breath while counterparties tried to determine the level of net payout exposure over LEH's default. All the while, wondering who, or what financial institution, might have to declare bankruptcy because of their CDS payout exposure.

CDS market has become a financial "nuclear wasteland" that became so large it threatened the entire financial system. Yet another example of regulators not doing their job.

Hope this summary helps...

About $2 trillion in credit derivatives in 1989 jumped to $8 trillion in 1994 and skyrocketed to $100 trillion in 2002. Last year, the Bank for International Settlements, a consortium of the world's central banks based in Basel (the Fed chair, Ben Bernanke, sits on its board), reported the gross value of these commitments at $596 trillion. Some are due, and some will mature soon. Typically, they involve contracts of five years or less.

Credit derivatives are breaking and will continue to break the world's financial system and cause an unending crisis of liquidity and gummed-up credit. Warren Buffett branded derivatives the "financial weapons of mass destruction." Felix Rohatyn, the investment banker who organized the bailout of New York a generation ago, called them "financial hydrogen bombs."

Both are right. At almost $600 trillion, over-the-counter (OTC) derivatives dwarf the value of publicly traded equities on world exchanges, which totaled $62.5 trillion in the fall of 2007 and fell to $36.6 trillion a year later.

The nice thing about public markets is that they act as canaries that give warnings as they did in 1929, 1987 (the program trading debacle), and 2001 (the dot-com bubble), so we can scramble out with our economic lives. But completely private and unregulated, the OTC derivatives trade is justly known as the "dark market."

http://www.villagevoice.com/content/printVersion/850296

The heart of darkness was the AIG Financial Products (AIGFP) office in London, where a large proportion of the derivatives were written. AIG had placed this unit outside American borders, which meant that it would not have to abide by American insurance reserve requirements. In other words, the derivatives clerks in London could sell as many products as they could write—even if it would bankrupt the company.

The president of AIGFP, a tyrannical super-salesman named Joseph Cassano, certainly had the experience. In the 1980s, he was an executive at Drexel Burnham Lambert, the now-defunct brokerage that became the pivot of the junk-bond scandal that led to the jailing of Michael Milken, David Levine, and Ivan Boesky.

During the peak years of derivatives trading, the 400 or so employees of the London unit reportedly averaged earnings in excess of a million dollars a year. They sold "protection"—this Runyonesque term was favored—worth more than three times the value of parent company AIG. How could they have not known that they were putting at risk the largest insurer in the world and all the businesses and individuals that it covered?

This scheme that smacks of securities fraud facilitated the dreams of buyers called "counterparties" willing to ante up. Hedge fund offices sprouted in Kensington and Mayfair like mushrooms after a summer shower. Revenue from premiums for derivatives at AIGFP rose from $737 million in 1999 to $3.26 billion in 2005. Cassano reportedly hectored ever-willing counterparties to "play the power game"—in other words, gobble up all the credit derivatives backing CDOs that they could grab. As the bundled adjustable-rate mortgages ballooned, stretched home buyers defaulted, and the exciting power game became about as risky as blasting sitting ducks with a Glock.

People still seem surprised to read that hedge principals have raked in billions of dollars in a single year. They shouldn't be. These subprime-time players knew how to score. The scam bled AIG white. In mid-September, when it was on the ropes, AIG received an astonishing $85 billion emergency line of credit from the Fed. Soon, that was supplemented by another $67 billion. Much of that money, to use the government's euphemism, has already been "drawn down." Shamefully, neither Washington nor AIG will explain where the billions went. But the answer is increasingly clear: It went to counterparties who bought derivatives from Cassano's shop in London.

Imagine if a ring of cashiers at a local bank made thousands of bad loans, aware that they could break the bank. They would be prosecuted for fraud and racketeering under the anti-gangster RICO Act. If their counterparties—the debtors—were in on the scam and understood that they didn't have to pay off the loans, they could be charged, too. In fact, this scenario played out at subprime-pushing outlets of a host of banks, including Washington Mutual (acquired last year by JP Morgan Chase, which itself received a $25 billion bailout); IndyMac (which was seized by FDIC regulators); and Lehman Brothers (which went belly-up). About 150 prosecutions of this type of fraud are going forward.

The top of the swamp's food chain, where the muck was derivatives rather than mortgages, must also be scrutinized. Apparently, that is the case. AIGFP's Cassano has hired top white-collar litigator and former prosecutor F. Joseph Warin (profiled in the 2004 Washingtonian piece, "Who to Call When You're Under Investigation!"). Neither Cassano nor his attorney responded to interview requests.

AIG's lavishly compensated counterparties were willing participants and likewise could be considered for prosecution, depending on what they knew. Who were they?

At a 2007 conference, Cassano defined them as a "global swath" that included "banks and investment banks, pension funds, endowments, foundations, insurance companies, hedge funds, money managers, high-net-worth individuals, municipalities, sovereigns, and supranationals." Abetting the scheme, ratings agencies like Standard & Poor's gave high grades to the shaky mortgage-backed securities bundled by investment banks such as Goldman Sachs and Lehman Brothers.

After the relative worthlessness of these CDOs became clear, the raters rushed to downgrade them to junk status. This occurred suddenly with more than 4,000 CDOs in the first quarter of 2008—the financial community now regards them as "toxic waste." Of course, the sudden massive downgrading raises the question: Why had CDOs been artificially elevated in the first place, leading banks to buy them and giving them protective coloring just because the derivatives writers "insured" them?

After the raters got real (i.e., got scared), the gig was up. Hedge funds fled in droves from their luxe digs in London. The industry remains murky, but some observers feel that more than half of all hedges will fold this year. Not necessarily a good sign, it seems to show that the funds were one-trick ponies living mainly off the derivatives play.

We know that AIG was not the only firm that sold derivatives: Lehman and Bear Stearns both dealt them and died. About 20 years ago, JP Morgan, the now-defunct investment bank, had brought the idea to AIGFP in London, which ran with it. Seeing the Cassano group's success, Morgan jumped in with both feet. Specializing in credit default swaps—a type of derivative triggered to pay off by negative events in the lives of loans, like defaults, foreclosures, and restructurings—Morgan had a distinctive marketing spin. Its "quants" were classy young dealers who could really do the math, which of course gave them credibility with those who couldn't. They abjured street slang like "protection." They pitched their sophisticated swaps as "technologies." The market adored them. They, in turn, oversold the product, made huge commissions, and wounded Morgan, which had to sell itself to Chase, becoming JP Morgan Chase—now the country's biggest bank.

Today, the real question is whether the Morgan quants knew the swaps didn't work and actually were grenades with pulled pins. Like Joseph Cassano, such people should consult attorneys.

If this don't make you shit in your pants what will?

larsr
about 2 hours ago
Now the CDS market was started to hedge credit exposure, but being unregulated, it soon became a market filled with financial "betting." In other words, folks bought and sold contracts among themselves based on whether they thought XWZ company would default or not, without ever owning the underlying bonds.

Blame Clinton on this one!
In 2000, the 106th Congress as its final effort passed the Commodity Futures Modernization Act (CFMA), and, disgracefully, President Clinton signed it. It opened up the bucket-shop loophole that capsized the world's economic system. With the stroke of a presidential pen, a century of valuable protection was lost.

No, ALL derivates were 600 trillion. CDS was just a portion of this. The above article was FLAT OUT WRONG. IRS make up the bulk of the 600 trillion.

"No, ALL derivates were 600 trillion. CDS was just a portion of this. "

yep. they were claimed to be around $60Tr outstanding, but after netting opposite positions they fell to about half of that.

Derivatives are a zero sum game - if one guy looses, the other guy wins. If the cds portfolio you sold starts to payout - it is a transfer of wealth. The real problem is that everyone, based on the generous ratings given by the agencies, went and borrowed more, even using existing derivative positions as collateral! In the end, it was reckless borrowing that brought the system down, not the derivatives (although they did contribute heavily to it). Every cdo originator was running their own Ponzi scheme based on liberal ratings.

"it is a transfer of wealth."

that doesn't really work with a very high counter party risk. that's the issue.

Back to the question of what happens if NYC defaults on its bonds. Before it gets to that point expect piecemeal service cutbacks like garbage collection/street cleaning one a week, closing down most of the free summer pools, canceling free concerts, events, etc... the city plays a game of chicken with the state and feds,slowly eroding the quality of life until there is enough pressure to get a new budget passed and terms amended on the existing debt. If that doesn't work and the city files under chapter 9, the police, fire and emergency personnel must continue to work without a contract (their old contract being voided due to bankruptcy), trains still run but everybody is really, really pissed off