TGIF

Financial Times today has a fine article on the fantasy world of credit default swaps. Obviously that is a “market” that should not exist, or if it does, should require 100% cash collateral for any writers of such “insurance”. See “Fantasy and Credit Insurance” under the “Markets” section in FT online - http://www.ft.com/home/us

There are two fundamental problems with such “insurance”, viz. (I) that there are really no natural writers and (II) any premium really involves two risks, the insured credit and the writer’s credit risk. These derivatives need to be regulated by the insurance regulators and real collateral put behind them, or they should be banned.

For now, persons looking at that “market” for “market” pricing are looking through grossly distorted lenses.

Another article in FT shows how derivatives are completely out of contact with markets. “The turmoil in financial markets has taken hold of the strategically important trade in long-term interest rate derivatives, pushing rates to levels once thought to be a “mathematical impossibility”.” … “On Thursday, the 30-year swap spread turned negative after briefly flirting with such levels earlier in the month. This implies investors are somehow reckoning that they are more likely to be paid back by a private counterparty than by the government, which can print money.”

“Negative swap spreads have been considered by many to be a mathematical impossibility, just like negative probabilities or negative interest rates,” said Fidelio Tata, head of interest rate derivatives strategy at RBS Greenwich Capital Markets.

So insurers and “investors who once bought bonds based on spread over Treasuries – i. e. a true, real risk premium - over time became dependent on “swap spread” for pricing. Of course, that was stupid since a swap is between two private parties and involves the credit risk of each. What a fantasy world created by people who probably never experienced a bankruptcy, or a panic or even read a book about the history of money & credit.

Some of these derivatives reminds me of the archaic “bills of exchange” that were the source of credit in early market economies of the industrial age. Those involved several endorsements, re-endorsements and counterparties, so were rather complex. A collapse of a major merchant or commercial lender would break the chains of endoresements and could create a cascade of trouble as many, many bills of exchange suddenly could have problems and trade at great discounts. Sound familiar ? Eventually were mostly replaced by modern commercial codes with standardized lending terms. “Wall Street” and the banking industry recreated such beasts with their inherent multiparty risks in the over-the-counter derivatives market … and proceeded to ignore those extra entanglements. This gets more & more like “Lord of the Flies” every week, as we see how the “Whiz Kids” created a cesspool as they had no adult supervision or understanding of history or reality.

This will eventually work its way out as people return to the old ways … old being 20-25 years ago. So far at least, despite the turmoil & shock, huge losses from derivatives settlements has not occurred. Most of the colossal notional amounts seem to be offset.

This mess can also be laid at the feet of Elmer, aka Alan Greenspan, as his “pro-derivative” testimony helped derail regulatory efforts in the late 1990s or early 2000s – I forget the exact dates but remember the event. Of course he also helped derail regulation of hedge funds. Like his predecessor, Paul Volker – the economic neutron bomber of the 1980s – both are true cluster FUBARs if one ever existed.

Markets

Today looks like an Asian selloff led by a Sony warning that has caused more Euro-beefer and US beefer liquidations. European markets and futures are down a lot, but I am getting acclimatized to these giant swings daily and intra-day. Fear continues to rule. And I presume the public continues to sell at the bottom. Over time, the baby boomers are really going to be hurt by these “Buy High, Sell Low", greed & fear tactics.

I continue to buy some of my favorite stocks on large dips. I still have quite a bit of buying power and safety net in my Alpha Fund.

I see the UK GDP fell in Q3. Can anyone explain why the Bank of England base rate is so high ? Ditto for the ECB ?

Word of the Day

“Comptoir” - noun [$1000] from French
Comptoir means a commercial agency or factory (in foreign country).
Sentence: When one reads histories of trade and credit in Europe in the early industrial age, the comptoirs of major trading nations such as the French or Dutch appear in places like Gdansk as they were active in the Baltic grain trade.