hi haim the WHAT I LEARNED THIS WEEK is a letter i get occasionally through the great daisy chain of pass-alongs. as the item comes by e-mail as e-mail (as opposed to attached files) i often fail to pass it on.
i make an exception of below content, which i do pass along so that i make sure i read them
just in in-tray (my comment, what a fine mess, almost funny)
1. Ceci N'est Pas Une Pipe
David Einhorn's Greenlight Fund and the associated investment vehicles have cashed in a large amount of sovereign CDS and replaced them with direct short positions in the bonds of countries thought to be ripe for default (such as Greece). Incidentally, CDS on Greece have now reached an incredible 14,395 basis points, i.e. it costs now 44% more to insure against a Greek default than the face value of the insured debt amounts to (this can be explained by the fact that Greek yields have risen so much - it makes sense to arbitrage a 330% bond yield against a 144% CDS premium, although this is not without risks).
Einhorn is understandably worried by the fact that the eurocrats have attempted to render CDS on Greece worthless as insurance by declaring the default a 'voluntary' event on the part of the creditors. And not unreasonably, he concludes that there is a lot of exposure among euro-land banks to the CDS market, and that he will escape the associated counterparty risk by shorting the bonds directly. As Einhorn notes, Magritte's surrealist painting 'The Treachery of Images' a.k.a. 'Ceci n'est pas une pipe' best describes the problem with euro area sovereign CDS. If you want to know why the painting of a pipe is not a pipe, try filling it with tobaccco. If you want to know why CDS on Greece are not insurance, try to collect.
Meanwhile, ISDA is debating the break-up of the euro and how this will alter existing euro-denominated derivatives contracts. This looks to be a potentially huge mess, as there 'is no plan' regarding a break-up, whereas there was a plan on occasion of the euro's introduction. Meanwhile, some members of ISDA are complaining that several members of the committee that determines what constitutes a credit event are 'voting their book'.
Includes several pdfs for download that give detailed background on the CDS market, including some info on the maths of default probabilities and how fundamental credit analysis can help with forecasting future CDS prices.
Also included, full update of euro-land credit market charts as of the end of last week.
acting-man.com
2. Interventionism vs. Markets - An Ongoing Struggle.
As the markets become ever more focused on what the next big intervention will be, they have lost quite a bit of their ability to give undistorted price signals to the market economy. This is inter alia demonstrated by the huge increase in intra-market correlations - the stock market's components are these days stronger correlated than even during the 1987 crash. This makes the discernment of company and sector-specific price information far more difficult - the rational allocation of capital suffers as a result. Economic calculation is the sine qua non of the market economy, but it is far from perfect even at the best of times. However, there can be no doubt that it is most effective when money is sound and the market economy not hampered. Neither condition exists today.
We take a look at Germany, home to a great many of the worst economic and sociological ideas ever thought up, which these days is ironically under attack for its positive traits and its refusal to take the easy way out. This brings us to the destructive ideologies that have replaced 19th century liberalism, to which we owe a far greater debt than is generally realized. It is to be hoped that the prendulum will swing back now that the opportunity has come for the interventionists to fail spectacularly. As Bob Hoye notes, it is dawning on people that 'unlimted government requires unlimited funding'.
Next year promises to be just as difficult as this year was. The markets will continue to be pushed and pulled by fresh interventions and the market-immanent desire to correct the excesses of the boom. We believe the 'potent directors' will increasingly be seen as unable to stem the tide. Already the markets are showing that they view the coming year with great apprehension. Those bond yields still regarded as 'risk free' all signal a prospectively weakening economy.
Meanwhile, Moody's downgrade of Belgium late on Friday serves as a reminder that the pressure on the euro area remains on. A slew of additional downgrades is likely to follow.
acting-man.com
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