Gyroscopic Investing

It seems like it would probably be a good thing for Greece to just default.  No restructuring, no extend and pretend...just make an announcement that all bondholders will get ZERO, nothing because the country is broke and anyone who lent it money should have known they might not be paid back.

When individuals do this in the context of a Chapter 7 bankruptcy, it actually makes them a much better credit risk going forward because all of their un-repayable debt no longer has to be repaid, and they are actually able to start building a solid financial future for themselves (assuming that's what they want to do).

Greece is starting to remind me of the fish strapped to the side of the boat in "The Old Man and The Sea" (the fisherman is the EU and the sharks are the usual cast of large financial institutions).  It's sort of sad and painful to watch it slowly be picked apart, all under the guise of "restructuring" and other meaningless buzzwords. 

I think that nothing good will happen in Greece until they get out from under the thumb of the IMF, ECB and whatever other entities to which they may have surrendered a portion of their sovereignty.

MediumTex wrote: It seems like it would probably be a good thing for Greece to just default. 

Definitely.  And it would certainly be better for the Euro. 

I wonder what would happen to the dollar (long term) if the Europeans started to really show this type of monetary discipline.

The problem, as I understand it, is that a great many American and European banks have sold CDS insuring greek bonds against default.  So, apparently there is that huge contagion issue of a greek default requiring another bailout of American financial institutions.

Does anybody else wish our government would just grow a pair of balls and say to the banks they can't sell CDS any more?  I mean it seems like Glass-Steagal should be reinstated and banks should only be allowed to perform banking functions, and not gambling with what inevitably becomes our money.

Privatized profits, public losses, it's the American way of doing crony capitalism...

But I'm definitely with you - I wish it would just default as well so we could get back to some kind of normalcy (whatever that is) in the market.

Storm,

Part of me would be against any outlawing of contracts between two parties, but 1) I don't understand what a CDS really even is, and 2) I realize there are systemic issues here.

I do think drawing a bright red line between banking and investing could be a great idea, though.  I feel like the combination of TBTF and erasing that line has lead to a lot of problems.

Storm wrote: Does anybody else wish our government would just grow a pair of balls and say to the banks they can't sell CDS any more?

Maybe those selling CDS should at least be required to prove that can cover what they are supposedly insuring. 

Since Greek banks hold a lot of Greek bonds, I expect that the Greek banks would be rendered immediately insolvent.  If they give the ECB the finger by defaulting, nobody will ride to the rescue of these banks.  At that point, I'm not sure how you keep the economy from derailing.

I'm afraid this would ultimately lead to civil unrest.  How could this be mitigated?

MediumTex wrote: I think that nothing good will happen in Greece until they get out from under the thumb of the IMF, ECB and whatever other entities to which they may have surrendered a portion of their sovereignty.

I completely agree.  Greece made some awful choices to get here (creating a national debt that they cannot service, building a public sector that can't be supported by their total productivity, surrendering sovereignty to the EU, etc.)  I'm just not sure how you unring the bell.

One thing that might give context to the recent problems in the euro-zone is this article:

http://www.zerohedge.com/article/exclus ... c-economy-

I usually tend to read Zerohedge articles with a boulder of salt, since they are sensationalist and play fast and loose with the facts, but perhaps there is some truth to the matter.

Part of me would be against any outlawing of contracts between two parties, but 1) I don't understand what a CDS really even is, and 2) I realize there are systemic issues here.

I do think drawing a bright red line between banking and investing could be a great idea, though.  I feel like the combination of TBTF and erasing that line has lead to a lot of problems.

Moda, a CDS or Credit Default Swap, is just an insurance policy on a financial instrument.  Say you're an investor and you really want that 20 or 30% rate the junk greek bonds are paying, but you don't want to take a risk of a default.  You buy a CDS from some US financial institution like JP Morgan and they guarantee that if the bond defaults, they will cover it.  If the bond doesn't default, JP Morgan makes a tidy sum, but if the bond defaults, they get screwed.

Maybe those selling CDS should at least be required to prove that can cover what they are supposedly insuring.

Adam, it seems to me that CDS wouldn't be very profitable without leverage - if a bank had to hold reserves to cover 100% of their CDS they would only be able to write a small number of them.

I can kind of see the argument from the banks side that if they are not allowed to sell CDS, then a lot of businesses and governments will never get financing, but my argument would be that if a business or government is not financially sound enough to get financing, we probably shouldn't be investing in them or guaranteeing their risky investments in the first place.

Another interesting couple articles:

http://blogs.reuters.com/felix-salmon/2 ... to-greece/

http://www.economist.com/blogs/democrac ... one-crisis

Storm wrote: I can kind of see the argument from the banks side that if they are not allowed to sell CDS, then a lot of businesses and governments will never get financing, but my argument would be that if a business or government is not financially sound enough to get financing, we probably shouldn't be investing in them or guaranteeing their risky investments in the first place.

I think banks should be allowed to sell CDS if that's what they want to do, but there shouldn't be the expectation that if the bets don't turn out well the U.S. and EU taxpayers will absorb the losses.

Based upon the AIG fiasco, I don't think it's a matter of financial institutions not having 100% reserves to cover potential losses.  It seems more like they don't even have 2% in reserves to cover potential losses.

These companies that sell CDS on a default on U.S. treasury debt are sort of comical.  How on earth could any company have sufficient reserves to weather a treasury default when it's the treasury that has kept them from going out of business every time they made a stupid bet like that in the first place.

It would be like a child writing a CDS on his parents' ability to pay on their debts.

Wonder if the EU will just print more Euros?

MediumTex wrote:
I think banks should be allowed to sell CDS if that's what they want to do, but there shouldn't be the expectation that if the bets don't turn out well the U.S. and EU taxpayers will absorb the losses.

I could not agree more with this, but I have wondered why the purchasers of CDS should be treated as if they were holding a Willy Wonka Golden Ticket. They have to assume risk as well, that their insurer could become insolvent. For those looking for a nice primer on credit default swaps, collateralized debt obligations, and the clusterf#%! that exploded in 2008, I suggest "The Big Short" , by Michael Lewis.

MediumTex wrote:I think banks should be allowed to sell CDS if that's what they want to do, but there shouldn't be the expectation that if the bets don't turn out well the U.S. and EU taxpayers will absorb the losses.

The trouble with this is the banks that sell CDS are systemically important - if they fail, then major companies and pretty much the economy itself will lock up.  Consider this sequence:
1) CDS writer fails - e.g. major player like JPMorgan or whatever
2) Money markets start breaking the buck. Nothing done to stop this. Run on money markets ensue.
3) Forced selling of corporate bonds backing MM happens, driving value down - causing more MM to break the buck, and more runs.
4) Some ATMs stop working, because JPMorgan or other banks get caught in the general panic
5) Lots of people start rioting, because w/out ATMs they have no way to buy food
6)

If you don't prohibit, or at least heavily regulate (require full collateral posting every night on an open exchange) banks writing CDS, then you will be forced to have "US and EU taxpayers to [provide bailouts and thus] absorb the losses."  You cannot have your cake (unregulated huge banks) and eat it too (avoid taxpayer bailouts).

fnord123 wrote:

MediumTex wrote:I think banks should be allowed to sell CDS if that's what they want to do, but there shouldn't be the expectation that if the bets don't turn out well the U.S. and EU taxpayers will absorb the losses.

The trouble with this is the banks that sell CDS are systemically important - if they fail, then major companies and pretty much the economy itself will lock up.  Consider this sequence:
1) CDS writer fails - e.g. major player like JPMorgan or whatever
2) Money markets start breaking the buck. Nothing done to stop this. Run on money markets ensue.
3) Forced selling of corporate bonds backing MM happens, driving value down - causing more MM to break the buck, and more runs.
4) Some ATMs stop working, because JPMorgan or other banks get caught in the general panic
5) Lots of people start rioting, because w/out ATMs they have no way to buy food
6)

If you don't prohibit, or at least heavily regulate (require full collateral posting every night on an open exchange) banks writing CDS, then you will be forced to have "US and EU taxpayers to [provide bailouts and thus] absorb the losses."  You cannot have your cake (unregulated huge banks) and eat it too (avoid taxpayer bailouts).

Or the government could take over such institutions when they become insolvent, wipe out the bondholders, fire management and start figuring out what can be salvaged, as we did in the S&L crisis.

But what I am saying about CDS in general is that there should be some kind of reserve requirements AND there should be the political will to let some of these big institutions fail. 

The idea of breaking up the big banks just like we have broken up railroads and utilities in the past is also not a bad idea.  If they truly are too big to fail, and they persist in behavior that risks failure, why not break them up?  It won't happen, of course, due to political considerations, but it's still a good idea IMHO.

MediumTex wrote:Or the government could take over such institutions when they become insolvent, wipe out the bondholders, fire management and start figuring out what can be salvaged, as we did in the S&L crisis.

But what I am saying about CDS in general is that there should be some kind of reserve requirements AND there should be the political will to let some of these big institutions fail. 

The idea of breaking up the big banks just like we have broken up railroads and utilities in the past is also not a bad idea.  If they truly are too big to fail, and they persist in behavior that risks failure, why not break them up?  It won't happen, of course, due to political considerations, but it's still a good idea IMHO.

Taking over the banks and wiping out the bondholders won't work for the TBTFs - too many of their bonds are held by other TBTFs.  When Lehman went down, it caused the Reserve MM to break the buck for instance - and Lehman was small change compared to our current TBTFs.

Breaking them up is a valid solution that would fix things, or requiring full reserve collateral at mark-to-market prices posted every night.  Anything short of these two will lead to future bailouts.

fnord123 wrote: Taking over the banks and wiping out the bondholders won't work for the TBTFs - too many of their bonds are held by other TBTFs.  When Lehman went down, it caused the Reserve MM to break the buck for instance - and Lehman was small change compared to our current TBTFs.

Breaking them up is a valid solution that would fix things, or requiring full reserve collateral at mark-to-market prices posted every night.  Anything short of these two will lead to future bailouts.

I agree, Fnord.  One interesting thing to note is that the stock market did not begin to go positive until March 2009, almost directly after the FSAB relaxed mark-to-market accounting rules and let the banks start listing mortgage backed securities on their book at fantasy levels again.

Storm wrote:

fnord123 wrote: Taking over the banks and wiping out the bondholders won't work for the TBTFs - too many of their bonds are held by other TBTFs.  When Lehman went down, it caused the Reserve MM to break the buck for instance - and Lehman was small change compared to our current TBTFs.

Breaking them up is a valid solution that would fix things, or requiring full reserve collateral at mark-to-market prices posted every night.  Anything short of these two will lead to future bailouts.

I agree, Fnord.  One interesting thing to note is that the stock market did not begin to go positive until March 2009, almost directly after the FSAB relaxed mark-to-market accounting rules and let the banks start listing mortgage backed securities on their book at fantasy levels again.

The banks today are like the railroads probably were 100 years ago.

Looking forward, I really don't know what the answer might look like.  Obviously, they need to get smaller and take on less risk, but I don't know how we get there from here.

Storm wrote:Moda, a CDS or Credit Default Swap, is just an insurance policy on a financial instrument.

Isn't one of the problems with the CDS that it's not *just* and insurance policy, insofar that lots of people can take out the insurance on the same financial instrument? I think in "Inside Job" Satyajit Das gave the example of home insurance. Only the owner of the home can take out home insurance. But with CDS, it's like a whole bunch of people can all take out insurance on my home. So if it burns down, the CDS insurer doesn't just have to pay me, but a whole bunch of people. So the loss is multiplied...

Edit: Yup, this is around the 38 minute mark. This is also the part where they talk about Joseph Cassano and AIG (@ 39:35):

Joseph Cassano wrote:It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions

He was correct, they lost *more* than one dollar....

jmourik wrote: Isn't one of the problems with the CDS that it's not *just* and insurance policy, insofar that lots of people can take out the insurance on the same financial instrument?

Absolutely correct, jmourik.  CDS allows anyone to play the insuring someone else game.  It's almost criminal to allow this - it basically sets people up to be bad actors and profit from the downfall of others.

Willem Buiter: Reasons to be cheerful about Greece
http://www.qfinance.com/blogs/ian-frase ... out-greece

[quote=Willem Buiter]Buiter accepts that Greece will default (or "restructure" or "reprofile" its debt). He also believes that Ireland and Portugal will default "soon after". But he rubbishes the doomsayers such as Peston and Lilico who claim that a Greek default will be Europe's "Lehman moment", complete with concomitant financial meltdown and a banking crisis even worse than that of October 2008.

The Citi economist said that sovereign debt in Europe is "pure vanilla", without many derivatives, and that the countries at risk of default are “small nations”? compared to a globally important institution like Lehman. Others now edging towards this line, especially if the defaults can be orderly, include the BBC Newsnight economics editor Paul Mason (see Greek default: end of the world or small patatas?)

Buiter also pointed out that when Lehman went bust it took financial markets largely by surprise; investors and national government have had time to ready themselves for a Greek default, even though some like the UK government of David Cameron do seem astonishingly complacent.[/quote]

It looks like we are getting pretty close to the endgame for Greece and its debt.

Anyone wish they had just defaulted a year or two ago?

Think about all the wasted effort and money that has gone into preventing what was probably inevitable all along.

Austerity, as usual, did nothing to help Greece in any way as far as I can see.

Could someone explain what would happen after a default in Greece?

I do not know much about economics, but here in Argentina after the default of 2001 disappeared foreign investment and credit (today have not recovered), there was a great social chaos in the streets, the number of poor ups by 25% and noone consider us a reliable country (ourselves buy dollars all the time to cover our savings and only bought Argentine bonds to speculate because always hovers the ghost of 2001). We had the luck that the prices of our commodities climbed rapidly as never before to boost the output of the crisis.

But what happens in a country like Greece if they don´t have this lucky, and What would be the long term impact in the Eurozone?

escafandro, I'm sure you know massively more about this than me because you have lived through a similar scenario in your own country. My understanding was that if Greece changed back to the Drachma and said that all its debts were now owed in free floating Drachmas rather than in Euros, then the effect would be an initial instantaneous fall in the new Drachma exchange rate. That would make petroleum and other imports expensive for Greek people but would mean that the debts were repayable. It would also give Greek exporters a competitive advantage. Without the yoke of unpayable debt, the Greek economy could subsequently recover. Greece is in an impossible situation as it is. I guess that is probably the least bad way out?

escafandro, my guess is that if Germany were to leave the euro, then the euro might work. Until that happens, the other countries will get picked off one by one until only Germany remains in the euro. The other alternative is that fiscal transfers mean that the euro zone becomes in effect one country as for India, USA, UK, Canada, Australia or any other country. India has lots of different languages and cultures much as europe has. The UK contains England, Scotland, Wales and Northern Ireland. If England play Argentina at football, all Scots or Welsh support Argentina. People in Europe do not want to be one country though. They realize that small countries such as Switzerland etc work well for the people. The euro project is just a way for politicians to try and force the people to join up as one large country IMO.

Ok, but the expectation is that Greece leave the euro along with the default or just go to default?
My new question then is if preferable go to default and so perhaps can pay his debt (good for Greece) knowing that this would lead to a loss of confidence in the country (loss of investment and credit, bad for Greece)?

Escafandro, if Greece just defaults and stays in the Euro and does not get fiscal union with Germany then it will just default again and again and again IMO.