Rajiv Sethi Tue 2010-06-15 14:25 EDT

Defenders and Demonizers of Credit Default Swaps

Rajiv Sethi

The recent difficulties faced by Greece (and some other eurozone states) in rolling over their national debt has let some to blame hedge fund involvement in the market for credit default swaps...Leaving aside the question of whether naked CDS trading has been good or bad for Greece, it is worth asking whether there exist mechanisms through which such contracts can ever have destabilizing effects. I believe that they can, for reasons that Salmon and Jones would do well to consider...such contracts allow pessimists to leverage (much more so than they could if they were to short bonds instead). The resulting increase in the cost of borrowing, which will rise in tandem with higher CDS spreads, can make the difference between solvency and insolvency. And recognition of this process can tempt those who are not otherwise pessimistic to bet on default, as long as they are confident that enough of their peers will also do so. This clearly creates an incentive for coordinated manipulation...

Credit Default Swap; defending; demonic; Rajiv Sethi.

China Financial Markets Tue 2010-04-20 09:17 EDT

Who will pay for China's bad loans?

Michael Pettis

...pessimists are starting to worry about excessive debt levels in China, about which they are very right to worry, and many are predicting a banking or financial collapse, which I think is much less likely. Optimists, on the other hand, are blithely discounting the problem of rising NPLs and insisting that they create little risk to Chinese growth. Their proof? A decade ago China had a huge surge in NPLs, the cleaning up of which was to cost China 40% of GDP and a possible banking collapse, and yet, they claim, nothing bad happened. The doomsayers were wrong, the last banking crisis was easily managed, and Chinese growth surged. But although I think the pessimists are wrong to expect a banking collapse, the optimists are nonetheless very mistaken, largely because they implicitly assumed away the cost of the bank recapitalization. In fact China paid a very high price for its banking crisis. The cost didn't come in the form of a banking collapse but rather in the form of a collapse in consumption growth as households were forced to pay for the enormous cleanup bill...

China Financial Markets; China's bad loans; pay.

naked capitalism Sun 2010-02-28 13:08 EST

Martin Wolf is Very Gloomy, and With Good Reason

Martin Wolf, the Financial Times' highly respected chief economics editor, weighs in with a pretty pessimistic piece tonight. This makes for a companion to Peter Boone and Simon Johnson's Doomsday cycle post from yesterday...With the private sector debt overhang as great as it is, I doubt there is a way out of our mess that does not involve a period of debt restructuring and writeoffs. That process, no matter how adeptly handled, results in dislocation and has a chilling effect on bystanders...Swedish Lex interestingly sees another possible brake that may become operative prior to another bubble/bust cycle. He believes that the EU has much less tolerance for underwriting zombie banks than the US. The EuroBanks have written off less in the way of losses than their US peers, are also exposed to any EU sovereign debt defaults, and yet the biggest are still crucial parts of the international capital markets infrastructure (and therefore still tightly coupled to the very biggest US/UK firms). While any EU sovereign debt defaults could morph into a full blown crisis, the EU responses to the joint sovereign/bank debt overhang could lead to more radical changes in EU banking rules and practices that could blow back to the very biggest US banks in unexpected ways.

gloomy; good reason; Martin Wolf; naked capitalism.