Credit Default Swaps Useless as Hedge Against Default; CDS on Greece a Purposeful Sham; Derivatives King Always Wins

As a result of labeling 50% haircuts "voluntary", Credit Default Swap contracts have proven to be useless when it comes to protecting against sovereign default. The serious implication is investors will need to find another way to hedge.

Bloomberg reports Greece Default Swaps Failure to Trigger Casts Doubt on Contracts as Hedge

The European Union’s ability to write down 50 percent of banks’ Greek bond holdings without triggering $3.7 billion in debt-insurance contracts threatens to undermine confidence in credit-default swaps as a hedge and force up borrowing costs.

As part of today’s accord aimed at resolving the euro region’s sovereign debt crisis, politicians and central bankers said they “invite Greece, private investors and all parties concerned to develop a voluntary bond exchange” into new securities. If the International Swaps & Derivatives Association agrees the exchange isn’t compulsory, credit-default swaps tied to the nation’s debt shouldn’t pay out.

“It will raise some very serious question marks over the value of CDS contracts,” said Harpreet Parhar, a strategist at Credit Agricole SA in London. “For euro sovereigns in particular, the CDS market is likely to remain wary.”

This approach may undermine confidence in credit-default swaps as a hedge and force banks to look at other ways of laying off risk, according to Pilar Gomez-Bravo, the senior adviser at Negentropy Capital in London, which oversees about 200 million euros ($277 million).

“If they find a way to avoid a trigger event in the CDS, then people will doubt the value of credit-default swaps in general, leading to more dislocations in the market,” she said.

“It is symptomatic of the regulatory and legal goalposts being constantly shifted either randomly or to suit political interests,” said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. “For genuine long-term investors, either financial or non-financial, it’s a major liability.”

CDS on Greece a Purposeful Sham

Janet Tavakoli writes “Standard” Credit Default Swaps on Greece Are a Sham and It’s Not a Surprise

“Customers” that accepted ISDA documentation when buying credit default protection on Greece are now discovering that ISDA defends the position that a 50% discount on Greek debt is “voluntary” and therefore not a credit event for credit default swap payment purposes according to its documents.

First Step in a CDS: Protect Yourself from the ISDA Cartel

As previous sovereign problems have illustrated, the only way to buy protection is to rewrite the flawed ISDA “standard” document and agree to new more sensible terms, before concluding the initial trade. One has to first protect oneself from the ISDA cartel “standard” documentation before one can buy sovereign default protection, or any other protection for that matter.

This isn’t the first time investors have been burned in the sovereign credit default swap market. Hedge funds Eternity Global Master Fund Ltd. and HBK Master Fund LP thought they purchased protection against an Argentina default and sued when J.P. Morgan refused to pay off on Argentina credit protection contracts they had purchased.

At issue was the definition of restructuring. Did Argentina's "voluntary debt exchange" in November of 2001 meet the definition of a restructuring? The Republic of Argentina gave bondholders the option to turn in their bonds in exchange for secured loans backed by certain Argentine federal tax revenues. J.P. Morgan claimed this didn't meet the definition of restructuring, at least for the protection it sold to Eternity.

J.P. Morgan's story was different when it wanted to collect on the protection it bought from Daehon, a South Korean Bank. J.P. Morgan claimed its slightly different contract language met the definition of restructuring under the credit default protection contract it had with the South Korean Bank.

In other words, J.P. Morgan made sure its contract language would allow it to get paid when it bought protection and would make it harder for its counterparty to get paid when it sold protection.

Language Arbitrage: You’re Not a Sucker, You’re a Customer

Banks that play this game call it “language arbitrage.” Anyone that bought sovereign credit protection on Greece after accepting ISDA “standard” documentation without modifying the language now finds that they are on the wrong side of an “arbitrage.” An arbitrage is a riskless money pump. In this case, it means that money has been pumped out of credit default protection buyers with no risk to their counterparties, the financial institutions that ostensibly sold them credit default protection on Greece.

Derivatives King Always Wins

Note how the "Derivatives King" JP Morgan wins on its contracts, even on both sides of essentially the same bet.

By the way, I have a couple of questions:

1. What the hell are banks doing in all these derivatives markets in the first place?


2. Isn't it time banks act like banks instead of arbitrage hedge funds?

Addendum:

Reader Scott writes ...

One look at the ISDA membership should disabuse anyone of the notion that this is some kind of neutral judge. The big banks that write most of the derivative contract also compose the group that defines a credit event. This is not much different than have a baseball pitcher call the balls and strikes. How this is legal is beyond me.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Massachusetts Supreme Court Foreclosure "Bombshell" Ruling Nothing But Hot Air

Many people sent links regarding a bombshell ruling in Massachusetts by the Daily Bail that allegedly "made foreclosure sales in the commonwealth over the last five years wholly void."

On Oct. 18th, 2011 the Massachusetts Supreme Judicial Court handed down their decision in the FRANCIS J. BEVILACQUA, THIRD vs. PABLO RODRIGUEZ – and in a moment, essentially made foreclosure sales in the commonwealth over the last five years wholly void. However, some of the more polite headlines, undoubtedly in the interest of not causing wide spread panic simply put it "SJC puts foreclosure sales in doubt" or "Buyer Can't Sue After Bad Foreclosure Sale."

In essence, the ruling upheld that those who had purchased foreclosure properties that had been illegally foreclosed upon (which is virtually all foreclosure sales in the last five years), did not in fact have title to those properties. Given the fact that more than two-thirds of all real estate transactions in the last five years have also been foreclosed properties, this creates a small problem.

The Massachusetts SJC is one of the most respected high courts in the country, other supreme courts look to these decisions for guidance, and would find it difficult to rule any other way in their own states. It is a precedent. It's an important precedent.

Clueless Hype

Let's first dispose of the nonsense that the "Massachusetts SJC is one of the most respected high courts in the country, other supreme courts look to these decisions for guidance, and would find it difficult to rule any other way in their own states."

The more important issue is the way sites trump up these cases with preposterous statements such as "In essence, the ruling upheld that those who had purchased foreclosure properties that had been illegally foreclosed upon (which is virtually all foreclosure sales in the last five years) ..."

The essence of the matter is the Daily Bail preaching clueless hype.

I asked Patrick Pulatie at LFI Analytics to chime in on the significance of the case. Pulatie writes ...

US Bank foreclosed upon the property, but no assignment to US Bank occurred until after the foreclosure. B then bought the property.

The court ruled that the foreclosure was unlawful, like in Ibanez. Therefore, B could not own the property. That said, the court ruled that if the Chain of Title could be corrected, then the foreclosure can be redone.

The author completely misrepresents the ruling like so many do. They claim that gold exists, where there is only lead. Unfortunately, this will only give homeowners more false hope.

What tells you how little the authors know is their claim the MA court is so well respected that other states will use the ruling as guidance.

That is laughable hogwash.

Third Opinion

We have heard from the Daily Bail and from Pulatie. Let's find a neutral party for a third opinion. I just happen to have one.

The Massachusetts Real Estate Law Blog asks What Now? Bevilacqua v. Rodriguez Leaves Toxic Foreclosure Titles Unclear

The Massachusetts Supreme Judicial Court issued its opinion today in the much anticipated Bevilacqua v. Rodriguez case considering property owners’ rights when they are saddled with defective titles ...

Contrary to some sensationalist headlines [linking to the Daily Bail], the sky is not falling down as the majority of foreclosures performed in the last several years were legal and conveyed good title. Bevilacqua affects those small percentage of foreclosures where mortgage assignments were not recorded in a timely fashion and were otherwise conducted unlawfully. Bevilacqua does not address the robo-signing controversy.

The Bad News

First the bad news. The Court held that owners cannot bring a court action to clear their titles under the “try title” procedure in the Massachusetts Land Court. This is the headline that the major news outlets have been running with, but it was not a surprise to anyone who has been following the case. Sorry Daily Kos, but the court did not take away a property from a foreclosure sale buyer. The buyer never owned it in the first place. If you don’t own a piece of property (say the Brooklyn Bridge), you cannot come into court and ask a judge to proclaim you the owner of that property, even if the true owner doesn’t show up to defend himself. It’s Property Law 101.

The Good News

Next the good news. The court left open whether owners could attempt to put their chains of title back together (like Humpty-Dumpty) and conduct new foreclosure sales to clear their titles. Unfortunately, the SJC did not provide the real estate community with any further guidance as to how best to resolve these complicated title defects.

It should be pretty clear now as to what is hype and what is not.

As far as precedent setting cases from respected courts, please consider 9th Circuit Court Ruling Legitimizes MERS.

As a followup post including an analysis of Assignment of the Deed of Trust in the California case Calvo v HSBC, please consider More on the Coming Wave of Foreclosures.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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The Economy, An Eye Popping Bloody Mess



Good News for Bears: Torture by Rumor Ends

A deal has been reached. While many decisions are yet to be made the agreed upon deal looks something like this:

• A "voluntary" haircut of 50% on Greek debt
• Bank recapitalization set at 106 billion euros
• EFSF will use leverage to get to at least 1 trillion Euros
• Leverage will be via a combination SIV plus Insurance plan
• Banks get an additional 21 billion Euros in "official aid"
• The ECB is going to continue to buy Italian bonds come hell or high water

A group of 70 European banks will need to raise 106 billion euros in the next eight months.

Recapitalization Breakdown

• Greek banks need 30 billion euros
• Spanish banks need 26.2 billion euros
• French banks need 8.8 billion euros
• Italian banks need 14.8 billion euros
• Remaining countries 26.6
  

Banks that fail to raise enough capital on the markets will first tap national governments, falling back on the EFSF rescue fund only as a last resort.

The above details pieced together from EU Sets 50% Greek Writedown, $1.4T in Fund and Impasse on Greek Debt Relief Threatens EU Crisis Summit Deal

The fuzziest point in the deal is in regards to what banks get the additional 21 billion Euros in "official aid", with what strings, and where the money comes from.

Good News for Bears

Although many details are yet to be resolved, the bulls got everything they wanted except endless printing by the ECB. However, the sad fundamental situation remains unchanged

1. No structural problems have been solved
2. Banks most assuredly need more than 106 billion in recapitalization efforts. The idea that French banks only need to raise 8.8 billion is preposterous.
3. No investors in their right mind will fund Greek and Spanish banks to the tune of 56.2 billion euros
   
4. The haircuts were not voluntary
   

Instead of the rumor mill of potential actions working to lift the market 24 hours a day for three straight weeks, it will be up to the EU to make the plan work. However, the plan won't work because of point number one above: not a single structural problem has been solved.

Although this rally may run for a while longer on fumes of past rumors and blind hope, it will eventually wear itself out.

Bear market rallies tend to end on good news. What more good news is coming?

The bulls got nearly everything they wanted, putting an end to torture by rumor. What could possibly be better news for the bears?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Manpower Manpower Manpower

Once again, we have the smartest readers in the world!

• A lone gunman quietly approached three men walking down a West Side street and opened fire, killing two of them and critically injuring the third, Chicago police said this morning.
  
  The broad daylight shooting happened just after 10 a.m. Tuesday in the 200 block of South Laramie Avenue in the South Austin neighborhood, according to police.
  
  The three victims, two 20-year-olds and a 24-year-old, were walking down Laramie when the gunman attacked, spraying all three victims with gunfire before vanishing, police said.

Once the third and first watches were inundated with manpower from the disbanding of the big citywide units and the office dead weight, our readers predicted that the criminals would move to where the pressure was less evident. This is among a number of brazen broad daylight shootings with multiple victims that have started to pop up on the radar. Also, our readers have been noting a trend of carjackings and armed robberies in formerly "quiet" areas of downtown. There are at least two different crews of armed robbers working the north side in Areas 3 and 5.

Manning the overnight watches at full strength or better is a great thing. But the criminals aren't complete morons. They will adapt, and unfortunately, they'll adapt faster than we'll change policy.

Protests Come to Rahm

Gee Rahm, bet you're glad to have the police around now?

• About 150 protesters with Occupy Chicago marched on City Hall this afternoon aiming to speak with Mayor Rahm Emanuel and "assert our First Amendment rights."
  
  But the mayor did not come out during a one-hour demonstration, and the protesters ended up handing over petitions to an aide demanding that they be allowed to occupy Grant Park.
  
  The demonstrators said the march was sparked by two weekends of arrests by people who sought to set up camp in the park. They were joined today by groups who plan to protest during next spring's NATO/G8 summit in Chicago.

As the weather turns colder, we imagine that the Occupy Chicago forces might need a permanent warm and dry place to continue protesting. That hallway looks pretty comfortable - we're just saying.

Dig Deeper

As the revenue from red-light cameras continues to flatten and even decline, Rahm's looking to squeeze more money from drivers - or at least, car owners:

• Bigger swathes of Chicago could wind up on video cameras under anti-speeding legislation that passed the Illinois Senate on Wednesday.

  The proposal, which passed 32-24 and now moves to the House, is being sought by Mayor Rahm Emanuel to help nab speeders around city schools and parks. The measure applies only to Chicago.

  “We have in Chicago a pedestrian fatality rate that’s 68 percent higher than in New York City, and we do lose a number of young children in these crashes in the city of Chicago,” said Senate President John Cullerton (D-Chicago), the bill’s chief Senate sponsor.

We'd really really like to see the statistical evidence for the speed cameras and the numbers floated around by politicians.

In a WBBM story, a reporter throws out this stat:

• ...approximately 84 percent of all pedestrian accidents in Chicago happen within a quarter mile of parks and schools.

This covers something like 60% of the landmass of Chicago and just happens to be areas where kids congregate, so it's going to be skewed. This reminds us of the "within a 1,000 feet of school/church PCS charge that covers something like 80% of Chicago and makes it all but impossible to avoid enhanced charges in the city.

In the same story, they quote a doctor:

• “We routinely see hundreds of kids a year hit by cars,” said Dr. Sally Reynolds, director of the emergency department at Children’s Memorial Hospital.

Sure you do - you're a hospital specializing in children. But Children's Memorial treats kids from the suburbs, downstate, and even out-of-state. Can we see the break down of Chicago kids treated who got hit in school zones? We're almost positive it will be a miniscule number. If we had hundreds of kids being struck by cars in school zones, we would have been redeployed there years ago and the headlines would have been screaming about the carnage in the streets. The media won't even cover the existing bloodbath in the minority communities of hundreds of gunfire deaths a year, but we're expected to believe hundred of kids are run over in school zones due to speeders?

Anyone want to bet the small number of kids hit by cars are as follows:

• unattended children -
• crossing away from designated crosswalks -
  
• out of sight of crossing guards -
  
• darting out from between parked vehicles -
  
• or negligent parents running over kids while backing up

But Rahm needs his $100. It's all for the children you know.