H Box, In answer to your question I think it only appropriate to reflect on Voltaire, the famous French Philosopher and Author, and Bon Vivant,, who in his major literary work Candide... has the Most notable Dr. Pangloss who has a maxim that he utilizes in helping the protagonist of the novel work through his despair....
" It begins with a young man, Candide, who is living a sheltered life in an Edenic paradise and being indoctrinated with Leibnizian optimism (or simply Optimism) by his mentor, Pangloss. [6] The work describes the abrupt cessation of this lifestyle, followed by Candide's slow, painful disillusionment as he witnesses and experiences great hardships in the world. Voltaire concludes with Candide, if not rejecting optimism outright, advocating a deeply practical precept, "we must cultivate our garden", in lieu of the Leibnizian mantra of Pangloss, "all is for the best in the best of all possible worlds""......
we can take the diametrically exact opposite of that..... and paraphrase that in that we can have quite negative outcomes in the worlds where we have adverse and bearish outcomes..... and thus in a deflationary contraction.... It Is not inconceivable that we could be looking at sub 666 SPX which we had on March 6th 2009......
| To: Hawkmoon who wrote (13591) | 2/14/2013 4:54:16 AM | | From: John Pitera | 3 Recommendations of 14172 | | | CounterParty Risk----I predict that the lynchpin of CounterParty Risk and the fact that it can not be hedged against will develop as The Ultimate Weak Linkin the Contractionary Forces inherent when less Leverage is pulled out of the Financial System.
who knew in 2007.... that was what would suck down AIG, Bear Sterns, Lehman, Citi.......
Message 23776642 | To: tyc:> who wrote ( 8081) | 8/9/2007 1:03:45 AM | | From: John Pitera | Read Replies (1) of 13620 | | Sure JAPAN after the top at the end of 1989. We had a very severe global recession/ quasi depression in 1973-1974 into 1975 and lingering for several years into the cusp of the 80's.
It's very Significant to consider how much the downturns of the Global Market and Credit downturns since 1987 have been dealt with by the central banks by a vast expansion of the broader Money supply numbers and the monetary aggregetes.
The wholescale mass Credit Creation and the Price Appreciation we have seen in so many areas, Especially in the price and Valuation of Financial Assets, Appears to be at the onset of a break down that will be a once in a 2 Generation Event, in Terms of Financial Distress.
I predict that the lynchpin of CounterParty Risk and the fact that it can not be hedged against will develop as The Ultimate Weak Linkin the Contractionary Forces inherent when less Leverage is pulled out of the Financial System.
John P |
|
---------------------
Message 25473946
please view my long term SPX Chart from March 7th of 2009 when we were at 666. and change... I was expecting at the minimum a quite active short covering rally as stoctrash comfirmed in the post directly after mine....
| To: Stoctrash who wrote (12090) | 3/7/2009 8:34:16 AM | | From: John Pitera | Read Replies (2) of 14172 | | | SPX long term chart with Fibonacci retracements.......
notice that the SPX low has been within 2 points of SPX 664 which is the longer term .618 retracement from the 1982 lows.
John
<img src="http://ih.fotothing.com/82419.jpg" img="" |
==================
| To: macavity who wrote (7182) | 8/25/2005 7:39:55 PM | | From: John Pitera | Read Replies (2) of 14172 | | | A 9 Fold Increase in Credit-Swaps Derivatives in 3 years, That's substantive. this article illustrates a potential
systemic weakness in the Financial System.
-------------------------------------------------------
Fed, Will Meet Over Derivatives August 25, 2005
By HENNY SENDER, MICHAEL MACKENZIE and RAMEZ MIKDASHI
Staff Reporters of THE WALL STREET JOURNAL
August 25, 2005; Page C3
The Federal Reserve Bank of New York will meet with Wall Street banks next month to discuss the still relatively opaque market for credit derivatives.
The market is a young but rapidly growing one where traders and investors use the derivatives to buy and sell protection against defaults. Trading volumes have soared, but back-office functions needed to make sure trades get completed haven't kept up with that growth.
It is these so-called settlement issues that the New York Fed wants to discuss with the bankers on Sept. 15. New York Fed President Timothy Geithner sent a letter to dealers on Aug. 12 inviting them to meet on "how best to address a range of important issues in the credit-derivatives market."
While those issues appear technical, they are essential to keep losses from snowballing into more systemic problems when the markets are volatile.
In May, for example, a downgrade of General Motors Corp. debt sparked violent moves in the market for credit derivatives and at least paper losses for Wall Street firms and the hedge funds on the other side of some trades. Those events led to calls for greater discipline and monitoring. More recently, problems surfaced when car-parts company Collins & Aikman Corp. filed for bankruptcy protection. A daisy chain of trades made it hard for many in the market to figure out who their ultimate counterparty was.
According to the International Swaps and Derivatives Association, the notional value of credit-default swaps outstanding reached $8.4 trillion at the end of 2004, a ninefold increase in just three years.
The New York Fed invited 14 banks from the U.S. and abroad but declined to name them. The credit-derivatives market is dominated by a handful of banks, including J.P. Morgan & Chase Co., Deutsche Bank AG, Morgan Stanley, Goldman Sachs Group Inc. and Citigroup Inc. Goldman Sachs and J.P. Morgan declined to comment, while other banks couldn't be reached for comment.
Hedge funds account for much of the recent surge in credit-derivatives activity. Banks welcome the funds as trading partners, but the funds sometimes move out of trades -- "assign" them -- without telling the bank that sold them the credit-derivative contract that their counterparty has changed. This makes it harder for other participants to know whether their positions are properly hedged.
Questions about the rising backlog of trades that haven't been settled have been with the market for some time. Indeed, the issues the Fed raises in its letter have been flagged by regulators in the United Kingdom and most recently in a report last month from the Counterparty Risk Management Group led by Gerald Corrigan, a former New York Fed president.
Federal Reserve Chairman Alan Greenspan and others have praised the role of the derivatives market in diluting financial risk, although the central-bank chief did warn in a speech in May of the potential risks to the economy if the use of derivatives isn't properly managed.
Banks and even some hedge funds say they welcome the Fed's initiative because it will help them focus on how to beef up their own back-office functions.
"We've always thought issues surrounding confirmations, settlements and assignments were really important, and have ourselves invested a great deal of time, money, people and technology to make sure that we've got this right," said Stephen Siderow, president of BlueMountain Capital Management, a hedge-fund manager overseeing investments of $2.7 billion. "We think these kinds of conversations between dealers and regulators can be very valuable."
--------------------------------------------------------
| To: John Pitera who wrote (7184) | 9/12/2005 3:44:25 PM | | From: John Pitera | Read Replies (1) of 14172 | | | Slices of Risk How a Formula Ignited Market That Burned Some Big Investors
Credit Derivatives Got a Boost From Clever Pricing Model;
Hedge Funds Misused It Inspiration: Widowed Spouses
By MARK WHITEHOUSE
Staff Reporter of THE WALL STREET JOURNAL
September 12, 2005; Page A1
When a credit agency downgraded General Motors Corp.'s debt in May, the auto maker's securities sank. But it wasn't just holders of GM shares and bonds who felt the pain.
Like the proverbial flap of a butterfly's wings rippling into a tornado, GM's woes caused hedge funds around the world to lose hundreds of millions of dollars in other investments on behalf of wealthy individuals, institutions like university endowments -- and, via pension funds, regular folk.
All this traces back, in a sense, to a day eight years ago when a Chinese-born New York banker got to musing about love and death -- specifically, how people tend to die soon after their spouses do. Therein lies a tale of how a statistician unknown outside a small coterie of finance theorists helped change the world of investing.
The banker, David Li, came up with a computerized financial model to weigh the likelihood that a given set of corporations would default on their bond debt in quick succession. Think of it as a produce scale that not only weighs a bag of apples but estimates the chance that they'll all be rotten in a week.
The model fueled explosive growth in a market for what are known as credit derivatives: investment vehicles that are based on corporate bonds and give their owners protection against a default. This is a market that barely existed in the mid-1990s. Now it is both so gigantic -- measured in the trillions of dollars -- and so murky that it has drawn expressions of concern from several market watchers. The Federal Reserve Bank of New York has asked 14 big banks to meet with it this week about practices in the surging market.
The model Mr. Li devised helped estimate what return investors in certain credit derivatives should demand, how much they have at risk and what strategies they should employ to minimize that risk. Big investors started using the model to make trades that entailed giant bets with little or none of their money tied up. Now, hundreds of billions of dollars ride on variations of the model every day.
"David Li deserves recognition," says Darrell Duffie, a Stanford University professor who consults for banks. He "brought that innovation into the markets [and] it has facilitated dramatic growth of the credit-derivatives markets."
The problem: The scale's calibration isn't foolproof. "The most dangerous part," Mr. Li himself says of the model, "is when people believe everything coming out of it." Investors who put too much trust in it or don't understand all its subtleties may think they've eliminated their risks when they haven't.
The story of Mr. Li and the model illustrates both the promise and peril of today's increasingly sophisticated investment world. That world extends far beyond its visible tip of stocks and bonds and their reactions to earnings or economic news. In the largely invisible realm of derivatives -- investment contracts structured so their value depends on the behavior of some other thing or event -- credit derivatives play a significant and growing role. Endless trading in them makes markets more efficient and eases the flow of money into companies that can use it to grow, create jobs and perhaps spread prosperity.
But investors who use credit derivatives without fully appreciating the risks can cause much trouble for themselves and potentially also for others, by triggering a cascade of losses. The GM episode proved relatively minor, but some experts say it could have been worse. "I think this is a baby financial mania," says David Hinman, a portfolio manager at Los Angeles investment firm Ares Management LLC, referring to credit derivatives. "Like a lot of financial manias, it tends to end with some casualties."
Mr. Li, 42 years old, began his journey to this frontier of capitalist innovation three decades ago in rural China. His father, a police official, had moved the family to the countryside to escape the purges of Mao's Cultural Revolution. Most children at the young Mr. Li's school didn't go past the 10th grade, but he made it into China's university system and then on to Canada, where he collected two master's degrees and a doctorate in statistics.
In 1997 he landed on the New York trading floor of Canadian Imperial Bank of Commerce, a pioneer in the then-small market for credit derivatives. Investment banks were toying with the concept of pooling corporate bonds and selling off pieces of the pool, just as they had done with mortgages. Banks called these bond pools collateralized debt obligations.
They made bond investing less risky through diversification. Invest in one company's bonds and you could lose all. But invest in the bonds of 100 to 300 companies and one loss won't hurt so much.
The pools, however, didn't just offer diversification. They also enabled sophisticated investors to boost their potential returns by taking on a large portion of the pool's risk. Banks cut the pools into several slices, called tranches, including one that bore the bulk of the risk and several more that were progressively less risky.
Say a pool holds 100 bonds. An investor can buy the riskiest tranche. It offers by far the highest return, but also bears the first 3% of any losses the pool suffers from any defaults among its 100 bonds. The investor who buys this is betting there won't be any such losses, in return for a shot at double-digit returns.
Alternatively, an investor could buy a conservative slice, which wouldn't pay as high a return but also wouldn't face any losses unless many more of the pool's bonds default.
Investment banks, in order to figure out the rates of return at which to offer each slice of the pool, first had to estimate the likelihood that all the companies in it would go bust at once. Their fates might be tightly intertwined. For instance, if the companies were all in closely related industries, such as auto-parts suppliers, they might fall like dominoes after a catastrophic event. In that case, the riskiest slice of the pool wouldn't offer a return much different from the conservative slices, since anything that would sink two or three companies would probably sink many of them. Such a pool would have a "high default correlation."
But if a pool had a low default correlation -- a low chance of all its companies stumbling at once -- then the price gap between the riskiest slice and the less-risky slices would be wide.
This is where Mr. Li made his crucial contribution. In 1997, nobody knew how to calculate default correlations with any precision. Mr. Li's solution drew inspiration from a concept in actuarial science known as the "broken heart": People tend to die faster after the death of a beloved spouse. Some of his colleagues from academia were working on a way to predict this death correlation, something quite useful to companies that sell life insurance and joint annuities.
"Suddenly I thought that the problem I was trying to solve was exactly like the problem these guys were trying to solve," says Mr. Li. "Default is like the death of a company, so we should model this the same way we model human life."
His colleagues' work gave him the idea of using copulas: mathematical functions the colleagues had begun applying to actuarial science. Copulas help predict the likelihood of various events occurring when those events depend to some extent on one another. Among the best copulas for bond pools turned out to be one named after Carl Friedrich Gauss, a 19th-century German statistician.
Mr. Li, who had moved over to a J.P. Morgan Chase & Co. unit (he has since joined Barclays Capital PLC), published his idea in March 2000 in the Journal of Fixed Income. The model, known by traders as the Gaussian copula, was born.
"David Li's paper was kind of a watershed in this area," says Greg Gupton, senior director of research at Moody's KMV, a subsidiary of the credit-ratings firm. "It garnered a lot of attention. People saw copulas as the new thing that might illuminate a lot of the questions people had at the time."
To figure out the likelihood of defaults in a bond pool, the model uses information about the way investors are treating each bond -- how risky they're perceiving its issuer to be. The market's assessment of the default likelihood for each company, for each of the next 10 years, is encapsulated in what's called a credit curve. Banks and traders take the credit curves of all 100 companies in a pool and plug them into the model.
The model runs the data through the copula function and spits out a default correlation for the pool -- the likelihood of all of its companies defaulting on their debt at once. The correlation would be high if all the credit curves looked the same, lower if they didn't. By knowing the pool's default correlation, banks and traders can agree with one another on how much more the riskiest slice of the bond pool ought to yield than the most conservative slice.
"That's the beauty of it," says Lisa Watkinson, who manages structured credit products at Morgan Stanley in New York. "It's the simplicity."
It's also the risk, because the model, by making it easier to create and trade collateralized debt obligations, or CDOs, has helped bring forth a slew of new products whose behavior it can predict only somewhat, not with precision. (The model is readily available to investors from investment banks.)
The biggest of these new products is something known as a synthetic CDO. It supercharges both the returns and the risks of a regular CDO. It does so by replacing the pool's bonds with credit derivatives -- specifically, with a type called credit-default swaps.
The swaps are like insurance policies. They insure against a bond default. Owners of bonds can buy credit-default swaps on their bonds to protect themselves. If the bond defaults, whoever sold the credit-default swap is in the same position as an insurer -- he has to pay up.
The price of this protection naturally varies, costing more as the perceived likelihood of default grows.
Some people buy credit-default swaps even though they don't own any bonds. They buy just because they think the swaps may rise in value. Their value will rise if the issuer of the underlying bonds starts to look shakier.
Say somebody wants default protection on $10 million of GM bonds. That investor might pay $500,000 a year to someone else for a promise to repay the bonds' face value if GM defaults. If GM later starts to look more likely to default than before, that first investor might be able to resell that one-year protection for $600,000, pocketing a $100,000 profit.
Just as investment banks pool bonds into CDOs and sell off riskier and less-risky slices, banks pool batches of credit-default swaps into synthetic CDOs and sell slices of those. Because the synthetic CDOs don't contain any actual bonds, banks can create them without going to the trouble of purchasing bonds. And the more synthetic CDOs they create, the more money the banks can earn by selling and trading them.
Synthetic CDOs have made the world of corporate credit very sexy -- a place of high risk but of high potential return with little money tied up.
Someone who invests in a synthetic CDO's riskiest slice -- agreeing to protect the pool against its first $10 million in default losses -- might receive an immediate payment of $5 million up front, plus $500,000 a year, for taking on this risk. He would get this $5 million without investing a dime, just for his pledge to pay in case of a default, much like what an insurance company does. Some investors, to prove they can pay if there is a default, might have to put up some collateral, but even then it would be only 15% or so of the amount they're on the hook for, or $1.5 million in this example.
This setup makes such an investment very tempting for many hedge-fund managers. "If you're a new hedge fund starting out, selling protection on the [riskiest] tranche and getting a huge payment up front is certainly something that's going to attract your attention," says Mr. Hinman of Ares Management. It's especially tempting given that a hedge fund's manager typically gets to keep 20% of the fund's winnings each year.
Synthetic CDOs are booming, and largely displacing the old-fashioned kind. Whereas four years ago, synthetic CDOs insured less than the equivalent of $400 billion face amount of U.S. corporate bonds, they will cover $2 trillion by the end of this year, J.P. Morgan Chase estimates. The whole U.S. corporate-bond market is $4.9 trillion.
Some banks are deeply involved. J.P. Morgan Chase, as of March 31, had bought or sold protection on the equivalent of $1.3 trillion of bonds, including both synthetic CDOs and individual credit-default swaps. Bank of America Corp. had bought or sold about $850 billion worth and Citigroup Inc. more than $700 billion, according to the Office of the Comptroller of the Currency. Deutsche Bank AG, whose activity the comptroller doesn't track, is another big player.
Much of that money is riding on Mr. Li's idea, which he freely concedes has important flaws. For one, it merely relies on a snapshot of current credit curves, rather than taking into account the way they move. The result: Actual prices in the market often differ from what the model indicates they should be.
Investment banks try to compensate for the shortcomings of the model by cobbling copula models together with other, proprietary methods. At J.P. Morgan, "We're not stupid enough to believe [the model] is omniscient," said Andrew Threadgold, head of market risk management. "All risk metrics are flawed in some way, so the trick is to use a lot of different metrics." Bank of America and Citigroup representatives said they use various models to assess risk and are constantly working to improve them. Deutsche Bank had no comment.
As with any model, forecasts investors make by using the model are only as good as the inputs. Someone asking the model to indicate how CDO prices will act in the future, for example, must first offer a guess about what will happen to the underlying credit curves -- that is, to the market's perception of the riskiness of individual bonds over several years. Trouble awaits those who blindly trust the model's output instead of recognizing that they are making a bet based partly on what they told the model they think will happen. Mr. Li worries that "very few people understand the essence of the model."
Consider the trade that tripped up some hedge funds during May's turmoil in GM securities. It involved selling insurance on the riskiest slice of a synthetic CDO and then looking to the model for a way to hedge the danger that the default risk would increase. Using the model, investors calculated that they could offset that danger by buying a double dose of insurance on a more conservative slice.
It looked like a great deal. For selling protection on the riskiest slice -- agreeing to pay as much as $10 million to cover the pool's first default losses -- an investor would collect a $3.5 million upfront payment and an additional $500,000 yearly. Hedging the risk would cost the investor a mere $415,000 annually, the price to buy protection on a $20 million conservative piece.
But the model's hedge assumed only one possible future: one in which the prices of all the credit-default swaps in the synthetic CDO moved in sync. They didn't. On May 5, while the outlook for most bond issuers stayed about the same, two got slammed: GM and Ford Motor Co., both of which Standard & Poor's downgraded to below investment grade. That event caused a jump in the price of protection on GM and Ford bonds. Within two weeks, the premium payment on the riskiest slice of the CDO, the one most exposed to defaults, leapt to about $6.5 million upfront.
Result: An investor who had sold protection on the riskiest slice for $3.5 million had a paper loss of nearly $3 million. That's because if the investor wanted to get out of the investment, he would have to buy a like amount of insurance from somebody else for $6.5 million, or $3 million more than he was getting.
The simultaneous investment in the conservative slice proved an inadequate hedge. Because only GM and Ford saw their default risk soar, not the rest of the bond world, the pricing of the more conservative slices of the pool didn't rise nearly as much as the riskiest slice. So there wasn't much of an offsetting profit to be made there by reselling that insurance.
This wasn't really the fault of the model, which was designed mainly to help price the tranches, not to make predictions. True, the model had assumed the various credit curves would move in sync. But it also allowed for investors to adjust this assumption -- an option that some, wittingly or not, ignored.
Because numerous hedge funds had made the same credit-derivatives bet, the turmoil they faced spilled over into stock and bond markets. Many investors worried that some hedge funds might have to dump assets to cover their losses, so they sold, too. (Some hedge funds also suffered from a separate bad bet, which relied on GM's bond and stock prices moving in tandem; it went wrong when GM shares rallied suddenly as investor Kirk Kerkorian said he would bid for GM shares.)
GLG Credit Fund told its investors it lost about 14.5% in the month of May, much of that on synthetic CDO bets. Writing to investors, fund manager Jean-Michel Hannoun called the market reaction to the GM and Ford credit downgrades too improbable an event for the hedge fund's risk model to capture. A GLG spokesman declines to comment.
The credit-derivatives market has since bounced back. Some say this shows that the proliferation of hedge funds and of complex derivatives has made markets more resilient, by spreading risk.
Others are less sanguine. "The events of spring 2005 might not be a true reflection of how these markets would function under stress," says the annual report of the Bank for International Settlements, an organization that coordinates central banks' efforts to ensure financial stability. To Stanford's Mr. Duffie, "The question is, has the market adopted the model wholesale in a way that has overreached its appropriate use? I think it has."
Mr. Li says that "it's not the perfect model." But, he adds: "There's not a better one yet."
Write to Mark Whitehouse at mark.whitehouse@wsj.com1
---------------------------------
| To: John Pitera who wrote (7187) | 9/15/2005 12:40:58 PM | | From: John Pitera | Read Replies (2) of 14172 | | | Credit Derivatives And Their Risks Are on the Table
By HENNY SENDER
Staff Reporter of THE WALL STREET JOURNAL
September 15, 2005; Page C1
The New York Federal Reserve Bank is gathering the big Wall Street players today. The topic: rising concerns about risk in what is known as the credit-derivatives markets.
The talks come amid frustration about the failure of the structure of the market to keep pace with the explosive growth in the trading of these complex securities.
"People have the best intentions, but there are resource issues," says Donna Parisi, head of the derivatives practice at the law firm of Shearman & Sterling. Credit derivatives, which allow investors to take positions on the risk of default of both companies and countries, have been one of the most rapidly growing financial products on Wall Street.
Infrastructure issues that have bedeviled the market involve processing and settling trades, or what some experts such as Thomas Russo, vice chairman of Lehman Brothers Holdings Inc., refer to as the "plumbing of the market." Such descriptions sound boring and technical. But the credit-derivatives arena has become increasingly important in terms of managing investment risk, which means regulators are eager to ensure that these complex and often opaque markets operate smoothly.
Thus far, their proddings have largely gone unheeded, leading to the unusual summit at the New York Fed.
The love-hate relationship between Wall Street firms and their hedge-fund clients has grown more acrimonious when it comes to credit derivatives. Hedge funds claim that Wall Street firms are reluctant to move to more efficient electronic trading and processing systems, because such a move would crimp the Street's margins. The dealers in turn say that hedge funds have been reluctant to invest sufficient funds in their back offices, and that it is the hedge funds, not Wall Street firms, that are the problem.
In any case, the result is stacks of paper at both hedge funds and at Wall Street firms. And the paper load is growing, as the labor-intensive review of documents and agreements confirming trades falls increasingly behind the growing volume of new trades.
"The burden gets bigger and bigger," says Robert Pickel, head of the International Swaps & Derivatives Association. ISDA provides master agreements for trades in the credit-derivatives market, but there is often a lot of debate about basic definitions of the trades, especially on what constitutes a default. The agreements "are only a partially completed canvas," adds Mr. Pickel.
The spotty record of confirmations can become a risk-management issue in times of turbulence. Such conditions occurred in May, when the gap between safer Treasurys and less-safe corporate bonds widened sharply. The trading turmoil that month has prompted several reviews of the market, with regulators trying to get a stronger handle on how best to ensure smoothness in the credit-derivatives market.
Valuations are another issue of contention. Since credit derivatives can be illiquid, hedge funds can garner a wide range of estimates on what a given position might be worth. Indeed, two different areas within a single investment bank have been known to give widely differing quotes on a given credit derivative, hedge-fund managers say. Who gets to say what a position is worth in times of volatility is an even more troubling issue, especially since it is such a critical element in assessing hedge-fund performance and the risk exposure of firms dealing with the hedge fund.
The Fed is also tackling the related, highly arcane issue of assignment. Hedge funds sometimes move out of trades -- "assign" them -- without telling the bank that sold them the credit-derivative contract. This practice makes it harder for other market participants to know whether their positions are properly hedged.
While the purpose of the meeting is simply "to discuss how best to address a range of important issues," according to the letter sent to 14 industry participants and a variety of international regulators, there is always the implicit threat of regulatory action.
"When things get relegated to the support areas, they sometimes often do not get the attention they deserve," says Mr. Russo, who was part of a private-sector group led by former New York Fed Chief Gerald Corrigan that looked at such risk issues. "Meetings such as those sponsored by the New York Fed are sometimes necessary to shine a light on a problem, mobilize people and bring about positive action."
|
-----------------------------------------------
| To: John Pitera who wrote (7188) | 9/15/2005 12:51:39 PM | | From: John Pitera | Read Replies (3) of 14172 | | | I am pretty sure that the problems with credit default derivatives especially the inability to accurately assess counter-party risk and counter party solvency are going to be a major factor in the next financial system blow up. The timing of this will probably coincide with an upcoming quick 275- 300 basis point sprint in the 10 year yield.
The bottom line is that with the daisy chaining of these sales and resales of the credit default protection contracts. Some players will end up overextended and unable to cover their default exposures.
The Valuation issue begs for misuse and future litigation as
hedge fund managers etc get sued for overstating the value of their contracts and getting paid 20 % of the inflated estimated value.
John |
--------------------------
| To: John Pitera who wrote (7188) | 9/15/2005 6:01:41 PM | | From: John Pitera | Read Replies (1) of 14172 | | | The FT reports that next week, the Federal Reserve Bank of New York will host an unusual gathering of 14 investment banks and their regulators. Timothy Geithner, president of the New York Fed, summoned the banks for a discussion of "important" issues in the fast-growing credit derivatives market.
The New York Fed speaks often with the banks it regulates, but the last such visible meeting occurred in 1998 – amid near-panic in the financial markets – as regulators scrambled to avert the collapse of Long-Term Capital Management, the US hedge fund.
Nobody is suggesting a meltdown is imminent this time. Brad Hintz, a securities industry analyst at Sanford Bernstein, said the move was a "natural response" by the New York Fed to market developments.
"With credit derivatives trading volumes doubling annually for the past five years, the infrastructure that settles those trades has been taxed and needs attention. This is merely a case of the Fed doing its job," he said.
Nonetheless, any pointers from the September 15 meeting will be watched by banks around the world. For example, the New York Fed could push credit derivatives dealers to standardise trading documentation and invest more in technology.
That would echo a report published in July by a financial industry group led by Gerald Corrigan, a former president of the New York Fed who is now a managing director at Goldman Sachs.
"We expressed some sense of genuine urgency," Mr Corrigan told the Financial Times. "It's a classic example of a situation in which the official community and the private sector should be and are working together."
Banks face two broad challenges, says Mr Corrigan. First, they have to deal with existing backlogs. Then, they have to ensure future trades are processed automatically so a backlog does not build up again.
The first of these efforts demands what he called a "three yards and a cloud of dust" approach, referring to a gritty, unglamorous American football strategy. Dealer banks and their clients simply have to comb through records to ensure their systems are up to date.
That sounds straightforward, and banks and industry bodies insist they are making progress. "The average time [to settle] credit derivatives reduced significantly from 17.8 [days] at end 2003 to 13.3 at the end of 2004," said Robert Pickel, chief executive of the International Swaps and Derivatives Association, suggesting the proportion of delayed trades was shrinking. But the speed of market growth makes it hard to keep up with existing orders, let alone deal with the backlog as well. "Some banks say they almost wish that the market could be closed for a month, just so they could catch up," said one international finance official.
Getting up to date with historical trades is only one part of the battle. For new trades, the goal is full automation – or "straight-through processing". That objective has spawned a rash of technological initiatives.
For example, the Depository Trust and Clearing Corporation – which settles most stock and bond transactions in the US – recently expanded its credit derivatives capability. A new start-up, T Zero, aims to improve the electronic transfer of trade information between systems. Meanwhile, MarketAxess and TradeWeb, rival electronic bond trading businesses, both said they planned to launch credit default swaps trading in the coming weeks.
"Automation of confirmation generation also improved significantly [between 2003 and 2004] from 24 per cent to 40 per cent," said Mr Pickel at ISDA. For several years, the organisation has been developing standardised documentation for derivatives trades – a prerequisite for automation.
The next challenge, which ISDA calls its "No.1 one priority", is to standardise assignments of credit derivatives trades. A bank and a customer may initially agree a trade. But later, the customer could decide to sell a position to a different bank. Such an assignment requires all three parties to agree – inviting delays and errors.
ISDA is working on a protocol to simplify assignments. Unusually, it is consulting fund manager groups as well as banks in an effort to satisfy all market participants. The move reflects the significance of hedge funds in the credit derivatives markets – and the fact that their requirements sometimes differ from those of the big Wall Street dealers.
That protocol should be released before next week's meeting at the New York Fed, and Mr Corrigan thinks a commitment to adopt it could be one outcome.
"I would imagine one of the things discussed at some length is [likely to be] a reasonable timescale to implement the new ISDA protocol to govern assignments," he said.
finfacts.com  |
---------------------
|
|
| To: John Pitera who wrote (7192) | 9/15/2005 6:45:38 PM | | From: John Pitera | of 14172 | | | Fed Calls in Banks on Derivatives Paperwork Backlog (Update2)
Sept. 13 (Bloomberg) -- The Federal Reserve Bank of New York called in representatives from 14 of the world's largest banks because their failure to erase a backlog of paperwork in the $8.4 trillion market for credit derivatives.
The meeting, announced by the Fed on Aug. 24, will be at the central bank's New York office on Sept. 15. It will bring bank representatives and risk managers together with U.S. and European regulators to discuss ``market practices,'' New York Fed spokesman Peter Bakstansky said in an interview.
Banks and securities firms are struggling to keep up with administration as the credit derivatives market grows. They risk being overwhelmed by investors seeking settlement of contracts if there is a corporate default, an industry group led by E. Gerald Corrigan, managing director at Goldman Sachs Group Inc. and a former New York Fed president, said in a report in July.
``Banks have been too focused on their own profit interests and in grabbing a share of the rapidly expanding market and haven't focused on operational issues,'' said Alistair Milne, senior lecturer on credit risk and settlement systems at Cass Business School in London. ``Systems, controls and accounting haven't kept pace with the growth in the market.''
JPMorgan Chase & Co., Deutsche Bank AG, Goldman, Morgan Stanley and Merrill Lynch & Co. are the five most-cited trading partners in credit derivatives, according to Fitch Ratings.
Like Insurance
JPMorgan will send Donald McCree, deputy head of risk management, and Eric Rosen, head of credit trading, to the meeting, said spokesman Michael Dorfsman in New York. McCree and Rosen, both based in New York, declined to be interviewed.
Goldman spokesman Michael DuVally and Morgan Stanley spokesman Mark Lake, both in New York, declined to comment. Merrill Lynch spokeswoman Terez Hanhan and Deutsche Bank spokeswoman Michelle Agostinho, also in New York, didn't return calls.
The banks didn't break down earnings from credit derivatives in their quarterly reports.
Credit derivatives are the fastest growing part of the $248 trillion derivatives market, based on the so-called notional value of the debts that underlie the contracts.
Credit-default swaps allow investors to bet on a company's creditworthiness or protect against a default. Like insurance, buyers pay an annual fee similar to a premium to protect a certain amount of debt against default for a specified number of years. In the event of a default, they are paid the face value of the bonds or loans.
13-Day Wait
The global credit-derivatives market more than doubled last year, mostly on demand for credit-default swaps, according to the International Swaps and Derivatives Association, or ISDA. The credit derivatives market wasn't even tracked until 1997.
A derivative is a financial obligation whose value is derived from interest rates, the outcome of specific events, or the price of underlying assets such as debt, equities and commodities.
ISDA, a New York-based trade group representing more than 600 securities firms, said credit-default swap trades went unconfirmed for 13 days on average last year, and for 18 days in 2003. ISDA Chief Executive Robert Pickel didn't provide an estimate for the total amount of default swaps that are currently unconfirmed.
LTCM
Corrigan's committee, which first met in 1999 after the collapse of hedge fund Long-Term Capital Management, called on banks to process more of their trades by computer and to consider cutting trading until the backlog is reduced. The report, released July 27 in New York, didn't provide an estimate of the dollar value of the backlog or the number of contracts awaiting confirmation.
The New York Fed brought together 14 banks and securities firms in 1998 to orchestrate the rescue of LTCM to avert a mass sell-off in financial markets. Banks and securities firms had loaned the collapsed hedge fund about $120 billion to make its bets.
``Having the attention of regulators gives the industry a push in the right direction,'' ISDA's Pickel said in an interview. ``It provides further impetus to address the issue sooner rather than later.''
About 40 percent of trades were sent out using automated systems last year, compared with 24 percent in 2003, ISDA data show.
`Inadequate Resources'
The U.K.'s Financial Services Authority in February said some transactions were left for months without being signed, and called for banks to work urgently to reduce the backlog before a crisis occurs. A number of firms are ``failing to resource their back-office functions adequately,'' the FSA said, without identifying any companies.
The FSA has since asked banks for an update on the delays, spokesman David Cliffe said.
``We're attending the meeting; we see this as a good opportunity to discuss the main issues in the industry,'' Cliffe said today, declining to comment further.
The settlement process for default swaps typically requires faxed signatures.
Confirmation delays are compounded when a seller of a credit- default swap transfers the contract to another firm, which then becomes responsible for payments in the event of a default. Sellers ``routinely'' reassign contracts in this way without seeking the consent of the original dealer, Corrigan's group said.
Assignments
The paperwork for these transactions, known as assignments, takes three times as long to complete, raising concern that the contracts might not hold up in the event of a default, Corrigan's group said.
``The trades that are done on automated systems are being confirmed on a timely basis,'' said Janet Wynn, general manager at Deriv/SERV, a computer-based processing system managed by the New York-based Depository Trust & Clearing Corp. ``The backlog has occurred in the paper world.''
Some transactions are more difficult to automate than others, Wynn said. Default swaps on a benchmark index can't be automated as easily as contracts on individual companies.
New York Fed President Timothy Geithner, who also serves as chairman of the Committee on Payment and Settlement Systems for the Bank for International Settlements, warned in a speech to the Securities Industry Association's national conference in New York in November 2004 of risks to the global financial system from the use of derivatives by hedge funds.
GM, Ford
The price of credit-default swaps jumped as much as 35 percent in May after Standard & Poor's stripped General Motors Corp. and Ford Motor Co. of their investment-grade ratings, causing a surge in demand for debt insurance from hedge funds and other investors.
JPMorgan in a June 9 report estimated about 90 companies worldwide, mostly investment banks and hedge funds, lost a total of $3.3 billion in the second quarter from trading so-called collateralized-debt obligations that group credit-default swaps.
Geithner urged the banks to send both ``a senior business representative and a senior risk management person'' to the meeting.
Regulators attending include the U.S. Securities and Exchange Commission, the Office of the Comptroller of the Currency, the New York State Banking Department, the U.K.'s FSA, Germany's Federal Financial Supervisory Authority and the Swiss Federal Banking Commission, said New York Fed spokeswoman Linda Ricci.
The New York Stock Exchange, Chicago Mercantile Exchange, the Chicago Board of Trade and the Chicago Board Options Exchange will also attend, Ricci said.
The NYSE will send Grace Vogel, executive vice president of member-firm regulation, said exchange spokesman Brendan Intindola. David Prosperi, spokesman at the Chicago Mercantile Exchange, and Maria Gemskie, spokeswoman at the Chicago Board of Trade, weren't immediately available to comment.
To contact the reporter on this story:
John Dooley in New York at jdooley@bloomberg.net.
Last Updated: September 13, 2005 06:21 EDT |
----
as you can see we are occassionally productive in the Market Lab and at GFA..
John Jacob Pitera |
