More on CDS

I tried to post this over on Dealbreaker's article, but their comment system appears to be screwed, so they get a Ticker dedicated to this....

"Equity Private" objected (I think) to my characterization on CDS, saying:

"We tend to be highly skeptical of any efforts to reduce pricing information. That is effectively what this is. Short selling bans and CDS bans only really reduce information available to the market. It is amazing to argue that credit default swaps (about the only counter balance to the insanity that was rating agency analysis) in the hands of evil hedge funds somehow precipitated the destruction of firms that were otherwise on the soundest of footing. "

Which of course misses the point.  The writers of these swaps were not on the "soundest of footing."  Indeed, perhaps Dealbreaker can manage to explain how AIG wrote some $500 billion in CDS against essentially zero capital behind them?  Oh sure, the company had a $1 trillion balance sheet, but essentially all of it was encumbered due to being collateral against their regulated lines of business.

If AIG had posted collateral against these CDS (or had them hedged via buying them from someone else) how is it that The Taxpayer has wound up with well north of $100 billion dollars stuffed into that black hole?  It certainly appears to this market participant that there was NO collateral kept and posted against the CDS that AIG wrote and they sure weren't hedged!

See, the problem isn't CDS per-se.  It's the same problem that exists with naked shorting - the ability to employ infinite leverage against a target which makes lots of money when the trade goes your way - but detonates your firm instantaneously when it does not.

No firm, irrespective of soundness, has the ability to meet an infinite capital requirement.

I have long argued that the height of insanity in this whole mess was removing the 12:1 leverage limits that formerly prevented investment banks from playing this sort of game - they were removed as a direct consequence of Henry Paulson's request while he was with Goldman in 2004, just before he was appointed to Treasury.

Never mind the dealer and ISDA arguments (adopted by the SEC and Congress) that CDS are not insurance contracts (regulated, with margin supervision) or even futures contracts (regulated, with both margin supervision and position limits) but rather are over-the-counter private agreements with no government regulatory oversight of any sort are the polar opposite of the transparency that Dealbreaker claims to be important:

"We tend to be highly skeptical of any efforts to reduce pricing information."

You do eh?  Then perhaps you can explain the argument for CDS being allowed to exist as private agreements between parties with zero disclosure of position sizes, bid and offer, and posted collateral?

Infinite leverage is always unsound and always distorts markets.  Further, "dark pools" where secrecy of position sizes, margin adequacy and prices can be kept from the public, irrespective of what is being traded, always distorts markets, making accurate evaluation by market participants and the public impossible. 

Dealers like this arrangement not only because it allows them to run unsound leverage without detection and sanction but also because it allows them to screw customers with impunity by selectively disclosing pricing information instead of having that data displayed on a public exchange where the best bid, best offer and open interest are known to all.

There are no exceptions to these facts, and that we continue to make excuses for what should be criminally-negligent (or worse) behavior is an outrage, especially when that infinite leverage is turned against The Taxpayer, as is now occurring.

"Returning to Mark-To-Myth accounting and abandoning "What My Assets Are Really Worth At The Time Of This Writing" accounting amounts to the same insanity. Anyone who claims that such marks are "unrepresentative because they are at fire sale prices" is merely imposing their long-term price forecasting on accounting policy. We've seen how well these long-term forecasters predict prices, so we'd like to pass on that plan, thanks."

I argue for no such thing; indeed, I argue for the precise opposite, and if Dealbreaker would have bothered to read more than one article from The Market Ticker then "Private Equity" would have known this.

Specifically, I have called for fully-transparent pricing and margin supervision on all entities and contracts written against same in written form for more than a year and a half, with one example found in the white paper transmitted to Congress called "Our Mortgage Mess."

Dealbreaker may want to do a bit more reading before assuming what someone has and has not promoted and argued for and against.