C.M.O. 3.25.2009
Credit Market Overview
March 25, 2009
Wall St. has often been described as a jungle and from the stories we read as children we have been told that the lion is the King of the Jungle. If, for the sake of argument, we accept these as true then in his day, George Soros was a lion. Mr. Soros contributed a piece to the WSJ Op/Ed section yesterday on the CDS market and what changes he feels should be made in the way it operates.
Before addressing the specifics of Mr. Soros’s suggestions I think it is important to review what exactly it was that made George a lion in his time. In 1992 George thought the British Pound was over-valued and began selling the currency short in hopes of profiting from his view. It is equally important to note that GS was operating in the FX market which, while deep and liquid, is to this day one of the least regulated markets that exists.
George built a position of over $10BN pounds using the cash as well as OTC derivative markets and eventually forced the Bank of England to withdraw from the European Exchange Rate Mechanism (a pre-cursor to the Euro) and devalue the pound. Taking on a nation’s central bank is a courageous thing to do but in order to win Mr. Soros could not concern himself with how his actions would affect millions of work-a-day Brits or the effects of his actions on the British economy. It is, after all a jungle and a lion must eat.
Given his past accomplishments I found George’s opinions on what changes should be made to the CDS market not completely in line with someone who has proven by his actions to be a champion of free markets.
Early in his piece GS rightly describes the reason for AIG’s demise as the selling of large amounts of CDS’s without properly hedging its exposure. Very shortly after that, however, he says that AIG would not have gone under if people that did not own the underlying bonds were not allowed to participate in the CDS market.
With all due respect to Mr. Soros I am going to debunk that premise immediately before reiterating the points I raised after Mr. Santoli offered a similar solution in Barron’s a few weeks ago.
AIG became insolvent because of the first point George mentions. They did not manage their risk correctly. The amount of protection AIG wrote, however, was less than the total issuance of CDO’s that existed at the time so AIG problems were not caused by an amount of open interest in the CDS market greater than the existing paper. They were caused, plain and simply, by AIG management who demanded that the Financial Products unit generate $1BN in revenue per year regardless of the risks attached. Therefore limiting CDS participation to bond holders only would not have changed the outcome for the CDS poster child of the credit crisis.
Yesterday’s Op/Ed piece also sites the limiting of CDS purchasing to bond holders as a way to prevent bear raids on the likes of Bear Stearns and Lehman Brothers. George Soros conducted a bear raid on an entire nation. He did so because he thought the currency was over valued and he did so by selling that currency short in what ever form he could; the cash market as well as non-exchange traded currency swap and option contracts with banks and investment banks as counterparties. Additionally he telegraphed his move through the press so that without actually colluding he made it easy for others to jump on board his trade adding even more ammunition to his assault.
As it turns out Bear Stearns and Lehman were proper targets of bear raids as their management’s, like AIG’s, mismanaged risk. I think George, of all people, would agree that regardless of the rules in place there are ways to express one’s views in the market place and to profit by them. In other words; where there is a will there is a way.
I also agree with George that the CDS market needs regulation. Not because the product itself is poorly designed but because the participants in that market place have proven that greed rules until fear takes over. (I am not denigrating greed here, just stating one of the basic concepts of the jungle.)
As for what kind of regulation would work best I offer here the same suggestions I made back on March 9th:
1) Place position limits on all participants that don’t own debt on the entity in question. (This is not to be confused with holders of short positions in the paper.) These position limits should apply across all asset classes on a combined basis so that someone shorting the stock cannot get around the reporting requirements for equities by using a combination of instruments to acquire a larger short position than otherwise possible given the reporting rules.
2) Holders of debt on an entity should be allowed to hedge 100% of their net long holding and any amount, up to but not exceeding, the limits described in 1) above.
I am not convinced that CDS contracts need to trade on an exchange as the well-oiled machine that is the foreign exchange market trades and settles Trillions of dollars of exposure a day without cataclysmic affect. The populist movement en vogue today will probably require the politicians to make this happen. The ICE and CME have already set up clearing entities. My feeling here is that the participants in the CDS market brought this on themselves and now they will have to live with the consequence.
I am still curious as to why George Soros, vacuus par speculator that he was has turned away from the thing that made him great. The lion is old, yes, but one has to wonder; is he sharpening his claws or looking at his paw to see where they used to be?
Enjoy the week.
Jim Delaney
March 25, 2009
Wall St. has often been described as a jungle and from the stories we read as children we have been told that the lion is the King of the Jungle. If, for the sake of argument, we accept these as true then in his day, George Soros was a lion. Mr. Soros contributed a piece to the WSJ Op/Ed section yesterday on the CDS market and what changes he feels should be made in the way it operates.
Before addressing the specifics of Mr. Soros’s suggestions I think it is important to review what exactly it was that made George a lion in his time. In 1992 George thought the British Pound was over-valued and began selling the currency short in hopes of profiting from his view. It is equally important to note that GS was operating in the FX market which, while deep and liquid, is to this day one of the least regulated markets that exists.
George built a position of over $10BN pounds using the cash as well as OTC derivative markets and eventually forced the Bank of England to withdraw from the European Exchange Rate Mechanism (a pre-cursor to the Euro) and devalue the pound. Taking on a nation’s central bank is a courageous thing to do but in order to win Mr. Soros could not concern himself with how his actions would affect millions of work-a-day Brits or the effects of his actions on the British economy. It is, after all a jungle and a lion must eat.
Given his past accomplishments I found George’s opinions on what changes should be made to the CDS market not completely in line with someone who has proven by his actions to be a champion of free markets.
Early in his piece GS rightly describes the reason for AIG’s demise as the selling of large amounts of CDS’s without properly hedging its exposure. Very shortly after that, however, he says that AIG would not have gone under if people that did not own the underlying bonds were not allowed to participate in the CDS market.
With all due respect to Mr. Soros I am going to debunk that premise immediately before reiterating the points I raised after Mr. Santoli offered a similar solution in Barron’s a few weeks ago.
AIG became insolvent because of the first point George mentions. They did not manage their risk correctly. The amount of protection AIG wrote, however, was less than the total issuance of CDO’s that existed at the time so AIG problems were not caused by an amount of open interest in the CDS market greater than the existing paper. They were caused, plain and simply, by AIG management who demanded that the Financial Products unit generate $1BN in revenue per year regardless of the risks attached. Therefore limiting CDS participation to bond holders only would not have changed the outcome for the CDS poster child of the credit crisis.
Yesterday’s Op/Ed piece also sites the limiting of CDS purchasing to bond holders as a way to prevent bear raids on the likes of Bear Stearns and Lehman Brothers. George Soros conducted a bear raid on an entire nation. He did so because he thought the currency was over valued and he did so by selling that currency short in what ever form he could; the cash market as well as non-exchange traded currency swap and option contracts with banks and investment banks as counterparties. Additionally he telegraphed his move through the press so that without actually colluding he made it easy for others to jump on board his trade adding even more ammunition to his assault.
As it turns out Bear Stearns and Lehman were proper targets of bear raids as their management’s, like AIG’s, mismanaged risk. I think George, of all people, would agree that regardless of the rules in place there are ways to express one’s views in the market place and to profit by them. In other words; where there is a will there is a way.
I also agree with George that the CDS market needs regulation. Not because the product itself is poorly designed but because the participants in that market place have proven that greed rules until fear takes over. (I am not denigrating greed here, just stating one of the basic concepts of the jungle.)
As for what kind of regulation would work best I offer here the same suggestions I made back on March 9th:
1) Place position limits on all participants that don’t own debt on the entity in question. (This is not to be confused with holders of short positions in the paper.) These position limits should apply across all asset classes on a combined basis so that someone shorting the stock cannot get around the reporting requirements for equities by using a combination of instruments to acquire a larger short position than otherwise possible given the reporting rules.
2) Holders of debt on an entity should be allowed to hedge 100% of their net long holding and any amount, up to but not exceeding, the limits described in 1) above.
I am not convinced that CDS contracts need to trade on an exchange as the well-oiled machine that is the foreign exchange market trades and settles Trillions of dollars of exposure a day without cataclysmic affect. The populist movement en vogue today will probably require the politicians to make this happen. The ICE and CME have already set up clearing entities. My feeling here is that the participants in the CDS market brought this on themselves and now they will have to live with the consequence.
I am still curious as to why George Soros, vacuus par speculator that he was has turned away from the thing that made him great. The lion is old, yes, but one has to wonder; is he sharpening his claws or looking at his paw to see where they used to be?
Enjoy the week.
Jim Delaney
Labels: CDS, CEC Strategy, correlation, credit, cross asset, equity, Jim Delaney
posted by Jim Delaney at
3:55 AM
1 Comments:
Did you know that George Soros would not be a multi-billionaire if it were not for the international language Esperanto?
Born in Hungary in 1930 as Gyorgy Schwartz, the family changed its name in 1936 to Soros, which in Esperanto means "to soar."
The Soros name-change was an effort to protect the Jewish family from the rise of fascist rulers and the whole family spoke Esperanto at home.
As a native Esperanto speaker, (someone who has spoken Esperanto from birth), George Soros defected to the West in 1946, while attending an Esperanto youth meeting in Switzerland.
Esperanto enabled Soros both to defect, and to become the 28th most wealthy man in the World, according to the Forbes rich list.
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