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KC native
01-26-2010, 01:07 PM
This is yet another example of how many on Wall St are simply out of touch with reality. Financial Reform needs to happen yesterday.

http://www.bloomberg.com/apps/news?pid=20601109&sid=aCb6JDT0sOWc&pos=10#

Banks Reviving Synthetic Bets as Volcker Blasts Default Swaps
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By Shannon D. Harrington and Pierre Paulden

Jan. 26 (Bloomberg) -- Wall Street is marketing derivatives last seen before credit markets froze in 2007 as the record bond rally prompts investors to take more risks to boost returns.

Bank of America Corp. and Morgan Stanley are encouraging clients to buy swaps that pay higher yields for speculating on the extent of losses in corporate defaults. Trading in credit- default swap indexes rose in the fourth quarter for the first time since 2008, according to Depository Trust & Clearing Corp. data. Federal Reserve data show leverage, or borrowed money, is rising in capital markets.

Investors who retreated to the safety of government debt during the financial crisis are returning to the simplest forms of so-called synthetic collateralized debt obligations after last year’s record 57.5 percent rally in junk bonds left money managers with fewer options. While President Barack Obama’s adviser Paul Volcker has blamed credit swaps and CDOs for taking the financial system “to the brink of disaster,” bankers say the instruments help companies raise capital.

“In a flight to quality you see investors fly away from anything exotic,” said Moorad Choudhry, author of “Structured Credit Products: Credit Derivatives and Synthetic Securitisation” and head of treasury in London at Europe Arab Bank Plc. “It’s now very slowly reversing, and if the recovery continues we will see it come back.”

Betting on Indexes

Bets using credit-default swap indexes that speculate on bonds without buying them have jumped 13 percent in the past three months to $1.2 trillion, DTCC data show. The amount includes index tranches, which may offer higher returns than indexes, according to Morgan Stanley and BlueMountain Capital Management LLC.

Derivatives, contracts used to hedge against changes in stocks, bonds, currencies, commodities, interest rates and weather, may boost yields for managers as if they were borrowing to purchase debt securities.

Bank of America strategists led by Suraj Tanna in London recommended that investors “rethink” so-called first-to- default baskets that pay investors for the risk that any one of four to 10 companies default. The trades “can provide an attractive premium relative to the total default risk the investor is taking,” the analysts said last month.

Morgan Stanley strategists suggested clients sell protection on a so-called mezzanine tranche of the Markit CDX North America Investment Grade Series 9 Index that would pay 3.8 percentage points annually for about five years. That’s more than triple the payments for a trade on the index, which is linked to 125 companies and used to speculate on corporate creditworthiness or to hedge against losses.

‘More Leverage’

In the mezzanine trade, holders start losing money after 7 percent of the investment’s value has been eliminated and lose everything after 10 percent.

As yields over benchmarks tighten, “investors are using more leverage to achieve return expectations,” said Bryce Markus, a money manager at New York-based BlueMountain, whose founders helped pioneer credit swaps. “These are very thin slices and a very junior part of the capital structure. If there is a misstep, the whole tranche could be wiped out.”

Speculative-grade bond yields have narrowed 15.4 percentage points relative to benchmarks since Dec. 15, 2008, when spreads were at a record 21.8 percentage points, according to the Bank of America Merrill Lynch U.S. High Yield Master II Index. The index has gained 1.45 percent this year, after the record rally in 2009.

Debt rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s is considered high yield, or below investment grade.

‘Easier to Understand’

CreditSights Inc., a New York debt research firm, predicts investors will initially return to first-to-default baskets and other “simpler structures” including credit-linked notes, or floating-rate securities created by selling a credit-default swap on an individual company.

Such trades are “significantly easier to understand compared to more complex, portfolio-based structures like bespoke tranches,” CreditSights strategist Atish Kakodkar wrote in a Dec. 9 note to clients.

One obstacle to the return of riskier derivatives is the dearth of experts after financial institutions fired more than 340,000 employees, including mathematicians who created these instruments.

“These are very complex and exotic products,” said Sasha Rozenberg, global head of credit products at SuperDerivatives Inc. in New York. “It’s going to take time to build up teams,” said Rozenberg, who joined the pricing provider in 2007 from Morgan Stanley, where he worked in the credit derivatives structuring group.

Lehman, Washington Mutual

UBS AG hired more than 200 people for its debt unit last year, including traders specializing in credit structures, to rebuild the fixed-income business after $57.5 billion in writedowns and losses at the Zurich-based bank, Switzerland’s largest. UBS spokesman Doug Morris in New York declined to comment.

While banks are recommending these trades, investors aren’t seeking out the riskiest derivatives that led to losses of as much as 90 percent after Lehman Brothers Holdings Inc. failed, said Sivan Mahadevan, a derivatives strategist at Morgan Stanley in New York.

The investments included customized synthetic CDOs that during 2006 and 2007 loaded their holdings with credit swaps linked to the debt of financial companies such as Lehman, Washington Mutual Inc. and bond insurers MBIA Inc. and Ambac Financial Group Inc.

$62 Trillion

Insurance companies, hedge funds and money managers seeking investments with the highest ratings and bigger returns than corporate bonds pushed the amount of credit protection sold through such synthetic CDOs in that period to about $1 trillion, according to a Morgan Stanley estimate in February 2008. Credit- default swaps rose to more than $62 trillion at the end of 2007, a 100-fold increase in seven years, surveys by the New York- based International Swaps and Derivatives Association show.

As Wall Street recommends more complex trades, investors are also augmenting bets with borrowed money. Some banks are offering as much as 10-to-1 leverage on securities backed by prime-jumbo home loans, said Scott Eichel, global co-head of asset- and mortgage-backed securities at RBS Securities Inc. in Stamford, Connecticut, a Royal Bank of Scotland Group Plc unit.

Fed data show that as of Jan. 6, the 18 primary dealers required to bid at Treasury auctions held $32.7 billion of securities aside from government, agency and agency mortgage bonds as collateral for financings lasting more than one day. On May 6, the amount was $15.8 billion and in 2007 the figure reached as high as $113.9 billion.

Obama Proposal

“There is added liquidity and greater price transparency than 12 months ago,” said Ashish Shah, a credit strategist at Barclays Capital in New York. “Leverage is coming back into the system, and that’s a good thing.”

Former Fed Chairman Volcker said last month there’s no clear link between financial innovations to limit risk, such as credit-default swaps, and increased economic productivity. Obama called for limiting the size and trading activities of banks to reduce risk-taking and avert another financial crisis.

“We intend to close loopholes that allowed big financial firms to trade risky financial products like credit-default swaps and other derivatives without oversight,” Obama said Jan. 21 in Washington.

Legislation is being debated in Congress designed to prevent the type of derivatives bets that pushed American International Group Inc. to the brink of bankruptcy in September 2008, threatening the global financial system. The proposed rules would require dealers and major market participants to process trades through a clearinghouse designed to contain losses if a firm fails. More capital would also need to be set aside for derivatives that aren’t cleared.

New rules may prevent a return to the riskiest bets in structured credit, said Kakodkar at CreditSights.

“Regulatory changes are likely to increase capital charges for bespoke or customized tranche trades,” he wrote in a report last month. That will force investors to focus on less risky versions of the swaps, he said.

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Pierre Paulden in New York at ppaulden@bloomberg.net
Last Updated: January 26, 2010 00:00 EST

Donger
01-26-2010, 01:25 PM
That's not really my language to be honest, but it sounds like investors are slowly going back to investing in potentially risky yet potentially very profitable ventures. Is that correct?

mlyonsd
01-26-2010, 01:28 PM
That's not really my language to be honest, but it sounds like investors are slowly going back to investing in potentially risky yet potentially very profitable ventures. Is that correct?

As long as government funds aren't used who would care except those risking their money?

Taco John
01-26-2010, 01:30 PM
The government that fueled this needs to step in and do what now?

HonestChieffan
01-26-2010, 01:38 PM
Massive regulation run by Fannie and Freddie. Thats the answer.

KC native
01-26-2010, 01:40 PM
That's not really my language to be honest, but it sounds like investors are slowly going back to investing in potentially risky yet potentially very profitable ventures. Is that correct?

They're going back into the same derivatives that caused AIG, Bear Stearns, Lehman's to collapse and a near collapse of everyone else.

The problem with these derivatives is they are extremely complex (very few people understand them) and there is no clearinghouse so there is no way to evaluate counterparty risk. Basically, Wall St is acting like it is 2007 all over again.

KC native
01-26-2010, 01:41 PM
The government that fueled this needs to step in and do what now?

The government didn't fuel shit on these. These derivatives were all created under the guise of "financial innovation".

Donger
01-26-2010, 01:42 PM
They're going back into the same derivatives that caused AIG, Bear Stearns, Lehman's to collapse and a near collapse of everyone else.

The problem with these derivatives is they are extremely complex (very few people understand them) and there is no clearinghouse so there is no way to evaluate counterparty risk. Basically, Wall St is acting like it is 2007 all over again.

So, I am correct?

KC native
01-26-2010, 01:45 PM
So, I am correct?

No, there has yet to be an entity that has been involved with these that has made real money with them (well without being paid out in full by the AIG bailout).

The article I posted about financial reform addressed these very derivatives.

Taco John
01-26-2010, 01:53 PM
The government didn't fuel shit on these.


That's funny, because I see "bail out" companies on this list. Am I wrong that we're talking about "bail out" companies?

KC native
01-26-2010, 01:58 PM
That's funny, because I see "bail out" companies on this list. Am I wrong that we're talking about "bail out" companies?

I know this may be hard to understand for someone like you but these derivatives were written/bought prior to the bail outs.

Donger
01-26-2010, 01:59 PM
No, there has yet to be an entity that has been involved with these that has made real money with them (well without being paid out in full by the AIG bailout).

The article I posted about financial reform addressed these very derivatives.

Then why are the chasing them?

KC native
01-26-2010, 02:07 PM
Then why are the chasing them?

Because Wall St is very good at convincing people to do stupid things especially people who don't have the knowledge they do.

Taco John
01-26-2010, 02:10 PM
I know this may be hard to understand for someone like you but these derivatives were written/bought prior to the bail outs.


Your article says that they are currently "marketing derivatives last seen before credit markets froze in 2007 as the record bond rally prompts investors to take more risks to boost returns." I fail to see the significance of when they were written in relation to the point I was making (which in essence is "the law of moral hazard is a bitch.")

It sounds like they're talking about things that are being done in the present tense. These are companies that would have likely failed had they not been bailed out that are currently not acting in ways that the government would like, no?

Donger
01-26-2010, 02:15 PM
Because Wall St is very good at convincing people to do stupid things especially people who don't have the knowledge they do.

You mean that Wall Street really doesn't have my best interest at heart?

Inspector
01-26-2010, 02:16 PM
Because Wall St is very good at convincing people to do stupid things especially people who don't have the knowledge they do.

Seems there should be a way to have some laws to protect us from any bad decisions we might make.

Darn it!!!!

Der Flöprer
01-26-2010, 03:04 PM
Who would've guessed that they'd go back and do the exact same shit? I mean, the consensus must be that we'll bail them out again if shit goes bad. That's what I would think if I was in their shoes.

Taco John
01-26-2010, 03:11 PM
Who would've guessed that they'd go back and do the exact same shit? I mean, the consensus must be that we'll bail them out again if shit goes bad. That's what I would think if I was in their shoes.

No kidding. Imagine that. You eliminate the consequences of their actions, and they continue to do the actions. Huh....

KC native
01-26-2010, 03:24 PM
FTR I was against the unstructured bailout we had and was in favor of the Swiss model to deal with issues like this. So moral hazard is what I've been complaining about from the beginning.

Der Flöprer
01-26-2010, 11:15 PM
FTR I was against the unstructured bailout we had and was in favor of the Swiss model to deal with issues like this. So moral hazard is what I've been complaining about from the beginning.

Everybody was against the bailouts. You wanna talk about the most bipartisan issue in the history of this country.............

It didn't stop anything. They did it anyways, and it took two Presidents from both of our political parties to make it happen. Who's in control? It's not us. Both sides are pushing our buttons in all the right ways to keep us at each others throats. That way, none of us will notice their hands in our back pockets. /Rant over

Mr. Kotter
01-26-2010, 11:58 PM
Everybody was against the bailouts. You wanna talk about the most bipartisan issue in the history of this country.............

It didn't stop anything. They did it anyways, and it took two Presidents from both of our political parties to make it happen. Who's in control? It's not us. Both sides are pushing our buttons in all the right ways to keep us at each others throats. That way, none of us will notice their hands in our back pockets. /Rant over

Pretty much...pathetic, ain't it? :shake:

Dylan
01-27-2010, 01:44 AM
The Wall Street Journal

JANUARY 27, 2010
The Obama Fisc

Spending religion arrives a year, and trillions of dollars, too late.


Meet President Obama 2.0. Unlike the 2009 version, this 2010 update isn't the spender who has sent the federal deficit to levels unseen since World War II. This new fellow is a fiscal conservative, and Americans will see this major new talent perform tonight as he delivers his State of the Union address.

Whether or not Americans choose to believe him, there's no denying the fiscal reality created by the rollout version of President Obama last year, as detailed in the Congressional Budget Office report released yesterday. For the second year in a row, fiscal 2010 will see a trillion-dollar deficit—an estimated $1.35 trillion, or 9.2% of GDP, which is down slightly from last year's post-World War II record of 9.9%.

Mr. Obama did inherit a recession, which is partly responsible for this ocean of red ink. The slow pace of economic recovery has contributed to a collapse in revenues, down to 14.8% of GDP in 2009 and an estimated 14.9% this year. That's well below the modern historical average of about 18.1%, and it is a reminder that economic growth is the most important contributor to smaller deficits. Had last year's "stimulus" worked half as well as the White House advertised, these deficits wouldn't be as large.

But as the nearby chart shows, Mr. Obama's major contribution to deficits has been a record spending spree. In 2007, before the recession, federal expenditures reached $2.73 trillion. By 2009 expenditures had climbed to $3.52 trillion. In 2009 alone, overall federal spending rose 18%, or $536 billion. Throw in a $65 billion reduction in debt service costs due to low interest rates, and the overall spending increase was 22%.
In one year.

CBO confirms that Democrats have taken federal spending to a new and higher plateau: 24.7% of GDP in 2009, 24.1% this year, and back to an estimated 24.3% in 2011. The modern historical average is about 20.5%, and less than that if you exclude the Reagan defense buildup of the 1980s that helped to win the Cold War and let Bill Clinton reduce defense spending to 3% of GDP in the 1990s.

This means that one of every four dollars produced by the sweat of American private labor is now taxed and redistributed by 535 men and women in Congress.
The slight deficit improvement for 2010 isn't due to any spending restraint. The feds will get a $218 billion windfall from reduced spending on TARP bailout cash, plus $27 billion in reduced deposit insurance outlays. All of that money and more is going right out the door again in $112 billion more in so far unspent stimulus, a 7% increase in nondefense discretionary spending, 6% more for Medicare and 11% more for Medicaid.

Compared to this gusher, Mr. Obama's touted spending freeze for some domestic agencies is the politics of gesture. It would apply to only 17% of the budget, and these programs have already had a 22% increase in their annual appropriations in the past two years, and another 25% increase including stimulus.

As for the deficit, CBO shows that over the first three years of the Obama Presidency, 2009-2011, the federal government will borrow an estimated $3.7 trillion. That is more than the entire accumulated national debt for the first 225 years of U.S. history. By 2019, the interest payments on this debt will be larger than the budget for education, roads and all other nondefense discretionary spending.

If this borrowing were financing defense investments or tax rate reductions to spur the U.S. economy, we wouldn't be worried. But most of this money is going to transfer payments to individuals, or subsidies to home buyers and inefficient businesses that do little for wealth creation.

As it always does, CBO forecasts that deficits will decline in the later years of its 10-year budget window. But this forecast depends on assumptions about Congress so fanciful that James Cameron couldn't make them up. CBO projects that all of the Bush tax cuts will expire in 2011—even those for the middle class—and that the Alternative Minimum Tax will hit more than 30 million mostly middle-class families over the next decade. Democrats say neither will happen.
CBO also assumes that Medicare will cut reimbursements to doctors by $250 billion, though Democrats have promised to stop such cuts in return for the American Medical Association's endorsement of their health bills.

If the middle-class tax cuts remain, the AMT doesn't soak the middle class and spending grows at its historic norm, then CBO concedes "the deficit in 2020 would be nearly the same, historically large, share of GDP that it is today and the debt held by the public would equal nearly 100% of GDP." Buongiorno, Italia.
Oh, and none of this includes a penny for ObamaCare.
***


http://online.wsj.com/article/SB10001424052748703906204575027181656362948.html#articleTabs%3Darticle

patteeu
01-27-2010, 08:50 AM
The government didn't fuel shit on these. These derivatives were all created under the guise of "financial innovation".

No, there has yet to be an entity that has been involved with these that has made real money with them (well without being paid out in full by the AIG bailout).

The article I posted about financial reform addressed these very derivatives.

You contradict yourself.

patteeu
01-27-2010, 08:57 AM
The Wall Street Journal

JANUARY 27, 2010
The Obama Fisc

Spending religion arrives a year, and trillions of dollars, too late.

...

Wow, that's a scathing indictment. No one with any sense of fiscal responsibility can continue to support this administration and their cronies in Congress. Nor can they continue to pretend that Bush and his Republican-controlled Congress were anything close to the same kind of careless spenders.

mlyonsd
01-27-2010, 09:13 AM
As for the deficit, CBO shows that over the first three years of the Obama Presidency, 2009-2011, the federal government will borrow an estimated $3.7 trillion. That is more than the entire accumulated national debt for the first 225 years of U.S. history. By 2019, the interest payments on this debt will be larger than the budget for education, roads and all other nondefense discretionary spending.



Wow. Just, wow.

KC native
01-27-2010, 09:38 AM
You contradict yourself.

Not at all. You do realize that those posts are talking about two completely separate points on the timeline of this crisis right?